IMF says credit rating agencies also liable for crisis

THE International Monetary Fund (IMF) said credit rating agencies and their rating methodologies may have inadvertently contributed to financial instability. In a report, the IMF said credit ratings influenced market prices, and that downgrades through the investment-grade barrier trigger market reactions, which were seen in the wake of the sharp downgrades of structured finance products during the recent financial crisis.

“The problem lies not entirely with the ratings themselves. In general, ratings are fairly accurate in foretelling when a sovereign is likely to default, though more attention to sovereign debt composition and contingent liabilities could help improve their rating decisions,” the IMF said.

The lender said concerns have been expressed about the conflicts of interest inherent in the issuer-pay business models of the major rating agencies that allow issuers to shop for high ratings.

“However, an investor-pay model can also give rise to conflicts of interest. For example, investors might pressure rating agencies to put off downgrades to delay forced sales of securities,” the IMF said.

Although credit rating agencies—Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s—have been under a cloud of suspicion following their role in structured credit markets, it should be acknowledged that ratings serve several useful purposes, the lender said.

“They aggregate information about the credit quality of borrowers, including sovereign entities, corporations, financial institutions, and their related debt offerings. They thus allow such borrowers to access global and domestic markets and attract investment funds, thereby adding liquidity to markets that would otherwise be illiquid,” the IMF said.

The report f showed that the market impact of credit rating agencies was associated not only with new information, but also with a “certification” role, though this is most evident through their use of “outlooks,” “reviews” and “watches” rather than actual rating changes.

The IMF prodded policymakers to work toward the elimination of rules and regulations that hardwire buy or sell decisions to ratings.
However, policymakers should recognize that smaller and less sophisticated investors and institutions will continue to use ratings, the lender said.

The IMF said it is important that the authorities continue efforts to push rating agencies to improve their procedures, including transparency, governance and the mitigation of conflicts of interest. –Lailany P. Gomez, Manila Times