The financial crisis has drawn considerable attention to the role of CRAs in the financial system. CRAs were originally private companies offering considered opinions on the quality of investments. The evolution of this role over time has left credit ratings hardwired into a wide range of regulatory and investment processes. CRAs can no longer be regarded solely as the providers of private goods to private markets. The crisis has demonstrated clearly that the public policy consequences of CRAs’ franchises need to be taken into account.

 

Abolishing CRAs is not an option. Other gatekeepers would emerge to fill the void with their own ratings-like research and advice. 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.

 

Reversing the hardwiring is challenging, but recent US legislation and the FSB’s publication of Principles for Reducing Reliance on CRA Ratings constitute an important first step.

 

Greater transparency in issuers’ financial information and improvements in financial firms’ capacity for internal assessment are pre-requisites for reducing reliance on ratings. Since such improvements will take time, it is important that the momentum behind recent initiatives is maintained.

 

However, even if the hardwiring of CRA ratings into regulation and certification were reduced, CRAs are sure to retain an important information role in financial markets. 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. This paper therefore also encourages deeper debate on how CRAs' business models might be modified or replaced to meet the legitimate market demand for unbiased credit opinions.