European Banks Want To Make Rating Agencies Stupider

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It's sort of easy these days to worry about banks. Banks do worrying things, etc. Bankers are only human and sometimes they get things wrong. Arguably those errors are systematically biased in favor of risk, what with the bankers being incentivized by asymmetric incentives and so forth.

One thing that could help you sleep at night is that other people are keeping a close eye on banks. Other people like their regulators. And like Moody's and S&P and Fitch. Also other people like, I don't know, David Tepper or something, but a thing to like about regulators and rating agencies specifically is that they have inside information. If you believe, as many do, that big banks are far too opaque for you to have any hope of evaluating them based on public disclosures, then the confidence of other public-market debt and equity investors - however smart and motivated by, y'know, the prospect of making money they might be - should only give you so much comfort: they're relying on the same opaque financials as you are. Regulators, on the other hand, can see literally whatever they want about a bank's book, and rating agencies can and do (sometimes) get lots of nonpublic information from the banks in formulating their ratings judgments. If the Fed and the OCC think a bank is sound, and Moody's and S&P think it is investment grade, who are you to worry about its creditworthiness? Don't answer that.

Anyway this is weird:

Up to 20 of Europe’s top banks will on Wednesday discuss a plan to foil the dominance of the much criticised big three credit agencies at a private meeting of finance directors in Frankfurt.

Some of the banks want to change the culture of information disclosure to the likes of Standard & Poor’s, Moody’s and Fitch to level the playing field for potential new entrants. “They get privileged information,” said one person familiar with the plan. “In future, maybe they should only get a standard pack, putting everyone on an equal footing.”

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"S&P, Moody's and Fitch have access to all the sensible information, get auditors' reviews and details on loans, asset valuations and everything," the banking source said, adding that newcomers might not get the same insight initially.

An EU lawmaker has already proposed an amendment to the draft law that would restrict agencies to using only publicly available information, a step aimed at boosting the chances of smaller agencies trying to muscle in on the business.

So, on the one hand, my mental model of Europe generally involves policymakers blaming any downgrades on flaws in the ratings agencies rather than in the underlying credit, so I guess it's not much of a stretch that bankers are doing the same when threatened with downgrades. On the other hand, what could possibly be the value of this to the banks? To start with, as Reuters puts it, "officials familiar with the Big Three said investors [sic] could end up losing out and end up with more conservative ratings if information available to agencies is restricted."

More generally, if rating agencies have to rely on public information, I guess that levels the playing field for non-big-three agencies. But it also renders the agencies ... wholly redundant, doesn't it? Right now the advantage of using ratings rather than, say, CDS prices to evaluate the creditworthiness of companies is that ratings are at least in theory the product of deep credit work by people with "auditors' reviews and details on loans, asset valuations and everything" - that is, they can at least in theory reflect information that the market doesn't know. Without that inside information, credit ratings will reflect only public information, as filtered through the opinion of people with much less incentive to be right than market participants have, and much more incentive to be generous.

If I were a bank, I'd be saddened by the prospect of being downgraded because the rating agencies become more conservative in response to being cut off from inside information. (Not least because it would probably require me to post more collateral.) I'd be even more saddened, though, if it became impossible to argue with a straight(ish) face that ratings provide useful information, since ratings are useful for banks both in capital calculations (where banks often prefer the easy approach of using ratings as a data point) and in selling securities to clients. Trying to kill off ratings just because you're getting downgraded seems a bit harsh.

Bankers discuss curbing rating agencies [FT, via @SallieKrawcheck (!)]
EU banks meet to discuss rating agencies -sources [Reuters]

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