## End the Credit Rating Addiction

_IMF Blog, September 30, 2010_

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**Canonical URL:** [End the Credit Rating Addiction](https://www.imf.org/en/blogs/articles/2010/09/30/end-the-credit-rating-addiction)

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- [Markdown version](/en/blogs/articles/2010/09/30/end-the-credit-rating-addiction/index.md)
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## Bibliographic details
- Authors: John Kiff
- Published: September 30, 2010

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### Role and intended value of credit ratings
- Credit ratings measure the relative risk that an entity such as a government or a company will fail to meet its financial commitments.
- In theory, credit ratings serve an incredibly useful role in global and domestic financial markets by aggregating information about credit quality and adding liquidity to otherwise illiquid markets.
- Agencies named as the main providers: Standard & Poor’s, Moody’s, and Fitch.

### Problems observed during the global financial crisis and sovereign debt strains
- Overreliance on ratings by borrowers, creditors, investors, and regulators contributed to financial instability.
- Ratings became "hardwired" into rules, regulations, and triggers:
  - Central banks often use ratings in their collateral acceptability rules.
  - The Basel II standardized approach to determining bank capital requirements relies heavily on ratings.
  - Institutional investors—pension funds, insurance companies, retirement funds—often have rules that trigger sales when securities are downgraded below certain levels.
- Mechanical reliance creates feedback loops:
  - Abrupt downgrades and even pre-downgrade warnings can prompt deleterious selloffs of securities.
  - Market reactions often occur when warnings are released rather than when the actual rating changes, triggering domino effects and broader spillovers.
- Sovereign ratings sometimes failed to account adequately for debt composition and contingent liabilities; in some cases (Greece cited) rating agencies lacked access to all necessary information.
- Not all investors have equivalent in-house capacity for risk assessment; smaller and less sophisticated institutions remain heavily dependent on third-party ratings.

### Key findings from the IMF background paper (Fall 2010 Global Financial Stability Report)
- Regulators should reduce their reliance on credit ratings.
- Markets need to "end their addiction to credit ratings."
- Credit ratings should be one of several tools to measure credit risk, not the sole or dominant one.
- Increasing oversight of the main rating agencies is warranted where their ratings continue to play key regulatory roles (for example, under the Basel II standardized approach).
- Policymakers should push rating agencies to improve procedures related to transparency and governance to provide greater assurance that ratings are fairly constructed.

### Policy recommendations and practical measures
- Remove mechanistic use of ratings in rules and regulations; some countries have begun this process.
- Persuade large investors to perform their own risk assessments as part of buy/sell decisions.
- Differentiate the process of reducing reliance on ratings according to the size and sophistication of institutions and the instruments being rated.
- Subject agencies whose ratings play key regulatory roles to increased oversight (both oversight and differentiation approaches were included in the recently signed U.S. financial sector reform legislation).
- Encourage countries to prepare and make publicly available a fiscal risk statement to improve information available to rating agencies.
- Continue reform efforts that aim to "wring out the volatility, without drying up the liquidity" provided by ratings.

*Authored by John Kiff; September 30, 2010 — IMF blog entry "End the Credit Rating Addiction".*

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## Content in this bundle

- **CHApTER 3 tHe uses and aBuses oF sovereIgn credIt ratIngs**
  - [CHApTER 3 tHe uses and aBuses oF sovereIgn credIt ratIngs (Markdown version)](/external/pubs/ft/gfsr/2010/02/pdf/chap3.pdf.md){rel="alternate" type="text/markdown"}
  - [CHApTER 3 tHe uses and aBuses oF sovereIgn credIt ratIngs (PDF)](/external/pubs/ft/gfsr/2010/02/pdf/chap3.pdf){rel="external" type="application/pdf"}

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## References

- [one of the background papers](http://www.imf.org/external/pubs/ft/gfsr/2010/02/index.htm)

_Source: https://www.imf.org/en/blogs/articles/2010/09/30/end-the-credit-rating-addiction_