Reducing Reliance on Credit Ratings
The global financial crisis highlighted widespread problems with risk management at financial institutions. One of the key issues highlighted post-crisis has been overreliance on ratings provided by credit ratings agencies (CRA) at the expense of effective in-house analysis of credit risk. This issue was compounded by flaws in the incentive structures for ratings agencies that were highlighted by the global financial crisis.
In October 2010 the FSB published Principles for Reducing Reliance on CRA Ratings. The goal of the FSB Principles is to end mechanistic reliance on CRA ratings by banks, institutional investors and other market participants by reducing the “hard wiring” of CRA ratings in standards, laws and regulations and by providing incentives for firms to develop their own capacity for credit risk assessment and due diligence.
The FSB Principles recognise that CRAs play an important role and their ratings can appropriately be used as an input to firms’ internal credit assessment processes. But any use of CRA ratings by a firm should not be mechanistic nor lessen a firm’s responsibility to ensure that its credit exposures are based on sound risk assessments. The Principles proceed from the basis that financial institutions should not invest in credits without conducting their own due diligence. At the same time, this does not imply that market participants should avoid all use of credit ratings, as long as they combine the use with exercise of their own judgement.