Will credit rating agency reforms be effective?
Journal of Financial Regulation and Compliance
ISSN: 1358-1988
Article publication date: 9 November 2012
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 inaccuracy 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
Citation
Boylan, S.J. (2012), "Will credit rating agency reforms be effective?", Journal of Financial Regulation and Compliance, Vol. 20 No. 4, pp. 356-366. https://doi.org/10.1108/13581981211279327
Publisher
:Emerald Group Publishing Limited
Copyright © 2012, Emerald Group Publishing Limited