Systemic Risk Of Credit Ratings

Amadou Sy, Deputy Division Chief, Africa, at the IMF Institute, over at the VOX blog, writes that the current regulatory attempts to improve the functioning of credit rating agencies are about eliminating conflicts of interest, increasing competition and improving transparency, but the proposals do not deal with systemic risk.

While Sy agrees with these efforts, he believes that when the ratings agencies make changes to the credit ratings of financial instruments, the changes can stress the financial system and be an important component of systemic risk in the financial system. Regulatory changes governing conflicts, competition and transparency do not directly deal with the systemic effects of ratings changes. The proposed changes will not help regulators avoid or mitigate the potential systemic risk caused by ratings changes.

He writes:

Credit rating agencies can increase systemic risk through unanticipated and abrupt downgrades. Such ratings crises can lead to large market losses, fire sales, and liquidity shortages and have knock-on effects on a number of systemically important market participants through legislation, regulations, supervisory policies, contractual arrangements, or investment practice.

Read the entire article here.