Banking regulators have announced their first proposal to replace the work of credit rating agencies, which came under fire in the aftermath of the financial meltdown, in rules that govern bank capital requirements.
The proposal by the Federal Deposit Insurance Corp., Federal Reserve and Office of the Comptroller of the Currency is a response to Dodd-Frank, which requires federal agencies to remove from their rule books references to the much-maligned credit ratings.
Prior to the 2008 financial meltdown, banks and other investors put much confidence in ratings given to mortgage bonds that later went bad. The Wall Street Journal notes that in writing the Dodd-Frank law, legislators were concerned that the federal government was "effectively putting its seal of approval on the ratings by publishing references to ratings in federal rules."
Until now, regulators had a tough time coming up with an alternative to the credit ratings agencies. Newly proposed alternatives include using assessments produced by the Organization for Economic Co-operation and Development on the fiscal health of individual countries to help evaluate the risk of sovereign debt held by banks. For some assets, market indicators such as stock price volatility would be used to measure risk.
The Federal Deposit Insurance Corp board has now voted to put out alternatives for comment through February 3.
The alternatives proposal would only directly affect a rule to update capital requirements regarding risks posed by banks' trading books. This rule applies only to large institutions with big trading operations, like JPMorgan Chase, Goldman Sachs and Citigroup.
Reuters notes however that the credit rating proposal is expected to form the basis for a rule to be released soon on how to get rid of references to credit ratings in all bank capital rules - a rule that will affect banks of all sizes. While some industry insiders commented that the credit-ratings replacement alternatives will create a more transparent environment, others were not as confident about the change.
From the Wall Street Journal:
[...} Acting Comptroller of the Currency John Walsh, said Congress should have provided regulators some flexibility for banks, particularly small ones, to use credit ratings. "In many areas, there are no alternative measures of creditworthiness that are as transparent and relatively simple to use," he said.