Banks and investors should end their dependence on credit ratings companies because it poses a danger to financial stability, a group of global regulators said.
The Financial Stability Board said that removing links between regulatory requirements and credit ratings would lessen “herding and cliff effects” that may push lenders toward insolvency when ratings are cut.
“Authorities should assess references” to credit ratings in “laws and regulations and, wherever possible, remove them or replace them,” the FSB said in a report on its website yesterday.
Regulators blame over-reliance on credit ratings for fueling the global financial crisis of 2008. Rules set by the Basel Committee on Banking Supervision forced banks to increase the capital they held against assets that were downgraded by ratings companies, leading to fire sales. Commitments to investors also forced banks to post extra collateral against securitized debt when it was downgraded.
The Dodd-Frank Act, signed by President Barack Obama in July, requires U.S. regulators to remove references to credit ratings of securities from their rules.
The European Commission will publish proposals by March to curb the reliance of regulation on credit ratings. Greece’s rating was cut to junk status by Standard and Poor’s in April, adding urgency to European Union plans to bail out the debt-plagued nation.
‘Free to Choose’
“We believe that investors should be free to choose the benchmark -- including credit ratings -- that best meets their needs while not mandating their use,” Chris Atkins, a spokesman for S&P, said in an e-mailed statement. He declined to comment on the specific FSB proposal since he hasn’t seen it.
Central banks should “reach their own credit judgments” on what assets to accept from financial institutions as collateral, the FSB said. It said also that “larger” banks should be expected to carry out their own risk assessment of “everything they hold.”
The Group of 20 countries set up the FSB last year, putting it in charge of coordinating efforts to strengthen global financial regulation in the wake of the crisis. It replaced the Financial Stability Forum, an advisory group with no formal role that was created in 1999 after the Asian financial crisis.
Its membership includes G-20 countries, international standard-setters such as the Basel committee, and international organizations such as the World Bank and the International Monetary Fund.
Mario Draghi, the FSB chairman, said last week in Seoul, Korea that reliance on credit ratings must be reduced.
Moody’s Investors Service “has long cautioned about over-reliance on ratings in regulation,” Michael Adler, a spokesman for the company, said in an e-mailed statement.
The financial crisis showed that regulators need flexibility to respond to events and not be bound by “overly mechanical triggers” that “can inadvertently amplify and increase risks in the system,” Adler said.