Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
I can tell you there's nothing but snickers around the table every time I attend a presentation about the Basel accords and the rating agencies come up.

For definiteness, here is the definition of a rating agency in the Basel accords: (source: Bank of International Settlements, Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version Part 2: The First Pillar - Minimum Capital Requirements

B. External credit assessment

1. The recognition process

90. National supervisors are responsible for determining whether an external credit assessment institution (ECAI) meets the criteria listed in the paragraph below. The assessments of ECAIs may be recognised on a limited basis, e.g. by type of claims or by jurisdiction. The supervisory process for recognising ECAIs should be made public to avoid unnecessary barriers to entry.  

2. Eligibility criteria

91. An ECAI must satisfy each of the following six criteria.

  • Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. Before being recognised by supervisors, an assessment methodology for each market segment, including rigorous backtesting, must have been established for at least one year and preferably three years.
  • Independence: An ECAI should be independent and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors or the shareholder structure of the assessment institution may be seen as creating a conflict of interest.
  • International access/Transparency: The individual assessments should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms. In addition, the general methodology used by the ECAI should be publicly available.
  • Disclosure: An ECAI should disclose the following information: its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, e.g. the likelihood of AA ratings becoming A over time.  
  • Resources: An ECAI should have sufficient resources to carry out high quality credit assessments. These resources should allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments should be based on methodologies combining qualitative and quantitative approaches.
  • Credibility: To some extent, credibility is derived from the criteria above. In addition, the reliance on an ECAI's external credit assessments by independent parties (investors, insurers, trading partners) is evidence of the credibility of the assessments of an ECAI. The credibility of an ECAI is also underpinned by the existence of internal procedures to prevent the misuse of confidential information. In order to be eligible for recognition, an ECAI does not have to assess firms in more than one country.
The observation is usually that no agency satisfies these conditions. So, national supervisors (that is, central banks) would be well in their rights to decree that the institutions they supervise are not required to use agency credit ratings to risk-weight their assets for regulatory capital purposes.

The brainless should not be in banking -- Willem Buiter
by Migeru (migeru at eurotrib dot com) on Thu Mar 25th, 2010 at 03:54:10 PM EST
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