Will credit rating agency reforms be effective?
| DOI | https://doi.org/10.1108/13581981211279327 |
| Date | 09 November 2012 |
| Pages | 356-366 |
| Published date | 09 November 2012 |
| Author | Scott J. Boylan |
| Subject Matter | Accounting & finance |
Will credit rating agency reforms
be effective?
Scott J. Boylan
Department of Accounting, Washington and Lee University,
Lexington, Virginia, USA
Abstract
Purpose – The purpose of this paper is to examine the potential effectiveness of government
reforms aimed at improving the accuracy of ratings issued by credit ratings agencies in US financial
markets.
Design/methodology/approach – The paper identifies unconscious bias as a source of inaccu racy
in the credit ratings process. It examines prior behavioral research on unconscious bias,
and uses this research to identify structural issues within the credit ratings industry that give rise
to biased judgments. Finally, it examines whether government reforms will be effective in
improving the accuracy of credit ratings, and offers additional reforms aimed at combating
unconscious bias.
Findings – Recent government reforms will be most effective in curbing intentional decisions to
compromise the ratings process. However, the reforms will be less effective at mitigating unconscious
biases in judgments underlying credit ratings, because they do not adequately address relevant
structural issues. To combat unconscious bias, changes need to be made to ratings agencies’ fee
structures, business models, and risk management functions.
Practical implications – The analysis is of use to regulators who are contemplating the need for
reforms aimed at improving the accuracy of credit ratings. While focusing on events in the USA, the
analysis is relevant to any country in which credit ratings are influential in financial markets.
Originality/value – This is the first paper to examine the performance of credit ratings agencies
through the lens of behavioral psychology, and to introduce the concept of unconscious bias as a
determining factor in the accuracy of credit ratings.
Keywords Credit rating,Credit, Bias, Experiment, UnitedStates of America, Financial markets
Paper type Research paper
On April 13, 2011, the US Senate Permanent Subcommittee on Investigations (2011),
chaired by Senator Carl Levin (D-Mich.), released a post-mortem analysis entitled,
Wall Street and the Financial Crisis: Anatomy of a Financial Collapse. The
subcommittee report, based on extensive interviews with US bankers, regulators,
and other market participants, concluded that one of the key contributors to the
financial crisis of 2008 was inflated credit ratings issued by agencies such as Moody’s,
Standard & Poor’s, and Fitch Ratings. The subcommittee identified several factors
contributing to the inaccurate ratings, including excessive competitive pressures
within the industry, flawed quantitative models, and bad data for those models.
Overall, the report paints a picture of an industry whose members were too eager to
please the investment banks which created the securities – and paid the agencies’ fees.
More specifically, the report concludes that the credit rating agencies were not
sufficiently careful in designing and evaluating the tests upon which their ratings were
based, and were too reluctant to revise their ratings when it was apparent that those
ratings were inaccurate. In response, the subcommittee recommended that the US
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
JFRC
20,4
356
Journal of Financial Regulation and
Compliance
Vol. 20 No. 4, 2012
pp. 356-366
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581981211279327
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