July 25, 2011

The “arbiters under fire” should be the bank regulators.

Sir, unfortunately, Aline van Duyn and Richard Milne, in “Arbiters under fire”, July25, fail to clearly identify the reasons why the current bank regulations based on credit ratings are so utterly wrong and make a decoupling such an urgent matter. Those reasons are in short the following: 

1. The market already considers the credit ratings when setting the risk premiums for a borrower which means that also using the same ratings when setting the capital requirements for banks give these ratings an exaggerated weight. Any information, exaggeratedly considered, is made wrong even if originally right. 

2. Regulators do not need to be concerned with credit ratings being right they should only worry about these being wrong. In this respect designing capital requirements for banks that are based on the credit ratings being absolutely right is absolute madness. 

3. Heisenberg´s uncertainty principle coming into play… the more precise you try to measure the creditworthiness of a borrower the more you might affect that same creditworthiness. 

4. The more you try to assure yourself the credit rating agencies perform their duties right, the more you are bound to trust them and consequentially the more fragile will the resulting financial system be. 

I am and have never been a bank regulator, but March 2003, in a published letter to the Financial Times I wrote “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”. Those arbiters who should really be under fire are the bank regulators.