Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Thu, 18 Jun 2009

Stocktaking on the use of credit ratings

Earlier this week, the Basel Committee (along with IOSCO and IAIS – the Joint Forum) published a report entitled “Stocktaking on the use of credit ratings” which documents the use of credit rating in banking, securities and insurance regulations in several major countries around the world. What struck me while reading the report is the fact that the US appears as an outlier in its pervasive use of credit rating in all aspects of its financial regulations.

Surprisingly, the UK uses credit ratings very little apart from what is mandated by Basel-II. In particular, the UK does not use credit ratings at all in determining what securities a regulated entity can or cannot invest in. (Just in case, one worries that somebody in the FSA might have made a mistake while checking boxes in the survey questionnaire, the report states categorically, “ the United Kingdom Financial Services Authority (UK FSA) noted that credit ratings are not used in any of its three financial sectors for asset identification.”)

For a country like India whose regulations use ratings quite extensively, this is an opportunity for a hard rethink. The current global crisis has shown that rating agencies can horribly wrong. More importantly, the crisis has reminded us that even when ratings measure idiosyncratic risk well, they are a poor signal of systemic risk.

Posted at 10:38 on Thu, 18 Jun 2009     View/Post Comments (4)     permanent link