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

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Sat, 15 Mar 2008

Is this the beginning of the end of credit rating?

A report by the US President’s Working Group (PWG) on Financial Markets released on Thursday could well be the beginning of the end of credit rating. It says

Overseers should ensure that [institutional] investors (and their asset managers) develop an independent view of the risk characteristics of the instruments in their portfolios, rather than rely solely on credit ratings.

...

The PWG member agencies will reinforce steps taken by the CRAs through revisions to supervisory policy and regulation, including regulatory capital requirements that use ratings.

In a different context, the report also says that “U.S. authorities should encourage other supervisors of global firms to make complementary efforts to develop guidance along the same lines.”

There is therefore a serious possibility that global regulators would wean institutional investors away from the use of ratings and also reduce the regulatory role of ratings. If that were to happen, would the rating agencies survive only on the basis of retail investors relying on the ratings? I doubt that very much. Long ago when Eurobonds were bought by Belgian dentists, ratings were hardly influential. Bonds were bought on the basis of name recognition – companies like IBM, Coca Cola and Walt Disney could borrow easily because they and their products were well known.

It is true that when the rating agencies began life a century ago, they did not need a regulatory monopoly to prosper. But that was before Altman showed that creditworthiness could be easily measured using econometric models based on accounting information and before the Merton model showed that the stock price by itself provides adequate information.

Posted at 10:26 on Sat, 15 Mar 2008     3 comments     permanent link

Comments...

Jason Mathew wrote on Tue, 25 Mar 2008 12:00

Re: Is this the beginning of the end of credit rating?

Good Informative post, I know that credit ratings is a big issue in the financial market. Well i would like to know more about the same.

Thanks, Jason

Jaffer Sadhiq wrote on Thu, 10 Apr 2008 14:38

Re: Is this the beginning of the end of credit rating?

I would like to thank you Prof. for taking this topic. I really dont know if this is the beginning of the end of the Credit rating agencies but I'm pretty sure that their reputation has taken a big hit because of the ongoing credit crises in the US.

Being a trader in the US markets, I noticed the mere collapse of bond insurers MBIA and Ambac Finacial. The price of both the companies plummeted because of the cautious comments by Moodys and S&P.

But having noticed the problem over a period of time, I noticed the rating agencies being contradictory in their statements about the bond insurers. Also i noticed the bond insurers sometimes denying the statements made by the rating agencies about their financial strength.

I also got the feeling that the rating agencies got bogged down by the market conditions in the US. I do feel that the reputation of the rating agencies have taken a hit and I dont deny that this might indeed be the beginning of their end.

kiroshimasylvia wrote on Fri, 23 Jul 2010 13:50

Re: Is this the beginning of the end of credit rating?

I like this particular article It gives me an additional input on the information around the world Thanks a lot and keep going with posting such information. I appreciate the concern which is been rose. The things need to be sorted out because it is about the individual but it can be with everyone. I like this particular article It gives me an additional input on the information around the world Thanks a lot and keep going with posting such information. ========================= <a href="http://www.creditscoresfree.org" rel="dofollow">Credit Score</a>