Rating agencies - only a light rap?

Moody's confession of a botched $1 bn securities rating, thanks to a computer bug, is only latest in a series of woes for the ratings industry. Let's face it- rating agencies are not the most popular species in the financial sector today. They had eggs on their face after the East Asian crisis; they seem to have gone and blown it again in the sub-prime crisis.

But it appears the agencies will get away with a mild rap or two. The Economist reported last month that despite half a dozen agencies looking into their role in the recent crisis, the outcomes will be inconsequential: a commitment not permit 'ratings shopping' among clients; more transparency; more disclosure of the collateral; and the like. No fines, no crippling prohibitions.

I guess part of the reason is that it's hard to find an alternative- an independent rating agency promoted by government and funded by investors through the exchanges is a non-starter because governments getting into financial markets is the last thing people want.

The role of rating agencies is poised to get bigger with the implementation of Basel II because, for starters, most banks will rely on the ratings approach- this requires capital to set aside based on ratings assigned to borrowers by rating agencies. Basel II itself is under discussion now. I think there is a case for allowing the better banks to go with their own internal ratings instead of requiring them to go by rating agencies' ratings.

In India, I can't see that the better banks' rating of borrowers is likely to be of lower quality than that of the agencies- most banks, in any case, use the rating models supplied by the agencies and superimpose their own judgement. This probably makes more sense than banks relying entirely on the rating agencies.