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State rating agency risks 'moral hazard'

Monday 28 March 2011 - by Nicola York

The Bank of England says a public rating agency is not the answer to the issues in the credit rating agency market, saying it could create "moral hazard'.

In a financial stability paper on CRAs, the BoE says that some in the industry believe the most straightforward answer to the problems of the CRA industry is to abolish the market altogether and establish a state rating agency instead.

But the BoE says this could create moral hazard because the state would therefore have to assume responsibility for any adverse consequences of its ratings decisions.

Secondly a public agency would not remove the conflict of interest problem that currently exists and would probably introduce a new conflict of interest when having to rate its own or other countries' sovereign debt.

It says: "Subsuming their role into a single public rating agency would also be fraught with difficulty: it would create false expectations, moral hazard and obstacles to innovation."

The paper rules out abolishing CRAs altogether, saying that other entities would emerge with their own ratings.

It says that reversing this "hardwiring" of reliance on CRAs is challenging but that recent US legislation and the Financial Stability Board principles are "an important first step".

It adds: "Recent enhancements to regulation of CRAs, and steps to improve their governance, transparency and accountability should help to manage any adverse consequences of the influence CRAs have. But there may be a case for structural reform - at least in the structured finance segment of the market - to tackle conflicts of interest."

Other structural reforms discussed in the paper include an investor-pays model or a ratings clearinghouse.

There have been calls from MEPs recently to create an independent European credit rating agency in an attempt to boost competition.

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