SEC Takes Steps to Undo NRSRO Monopoly And Capital Arbitrage

The Securities and Exchange Commission voted unanimously to take rule making action to bolster oversight of credit ratings agencies.

Currently, 10 credit rating agencies are registered with the Commission as NRSROs (Nationally Recognized Statistical Rating Organizations). The SEC adopted amendments to the Commission's rules and forms to remove some of the references to credit ratings by nationally recognized statistical rating organizations.

Additionally, the SEC reopened the public comment period to allow further comment on Commission proposals to eliminate references to NRSRO credit ratings from other rules and forms.

If the banking regulators follow suit to remove references to NRSROs in capital requirements, the whole process of securitizing loans to raise the credit rating of the loans in order to lower the capital requirements will come to a halt.

Securitization will still occur because it frees up the capital deployed in the initial lending. Eliminating references to NRSROs ratings as a determinate for the amount of bank capital will prevent the capital arbitrage that occurred during the past financial crisis.

Removing the ability to capital arbitrage residential mortgage loans is the single most important step in reforming the credit rating agencies.

Under current capital rules, home mortgages require capital for 50 percent of the loans. By securitizing and raising the credit rating, the amount of capital was reduced to 20 percent of the loans. The process enabled banks to hold 2 and 1/2 times as much securitized residential mortgage loans as unsecuritized residential mortgage loans.

Read the complete SEC press release here.