Regulators’ Search for Credit Rating Alternatives Likely to Be Tough

By Joe Adler

Regulators are poised this week to start moving away from reliance on the tarnished credit rating agencies in the supervisory process, but finding other options likely will be difficult. The Federal Deposit Insurance Corp. is scheduled to meet Tuesday to discuss alternatives to external ratings in setting capital requirements — the start of a yearlong process under the regulatory reform law requiring regulators to find other credit information sources. Although lawmakers and regulators agree the steps are necessary, observers said the agencies are venturing into uncharted waters. At issue are the ratings handed out primarily by the three largest agencies: Moody’s Corp., Fitch Inc. and Standard & Poor’s. The ratings serve chiefly to help investors assess the strength of a company or portfolio. Before passage of the reform law, regulators were said to be considering changes to make implementation of Basel II less reliant on the rating agencies. In April the FDIC proposed eliminating debt-issuer ratings as a factor in setting the deposit insurance premiums for large banks. “The regulatory community has been considering this challenge well before the Dodd-Frank Act,” said Tom Deutsch, the executive director of the American Securitization Forum. But, he added, “The question remains: What do you use as the alternative? Do you use the bank’s internal assessments of their risk? Do you use some other objective third party? Is some other third party going to be more qualified at predicting risks than the rating agencies, which have very large, sophisticated staffs? I’m not sure we’ll see any alternative that will be a perfect solution for such a challenge.” Others said that, though the regulators face a difficult task, it is crucial to find an alternative to the credit rating agencies. “The objectivity of the rating agencies is at best a matter of dispute,” said Karen Shaw Petrou, the managing partner of Federal Financial Analytics Inc. “The way to make regulatory decisions without resorting to the rating agencies is for regulators to understand risk based on credible analytics and to rely on proven forms of risk mitigation.