The role of credit ratings in the Basle capital adequacy proposals

The Basel Committee on Banking Supervision is proposing to introduce credit ratings into the regulatory process by linking banks’ capital requirements to the ratings of borrowers. The use of credit ratings for regulatory purposes raises a number of policy issues, including the reliability of ratings as indicators of default risk, the consistency of ratings across agencies and countries, the possible abuse of the ratings process itself through “rate-shopping” for the higher ratings, and the relationship between ratings of external rating agencies and banks’ internal ratings. In this study, Dale and Thomas investigate the role of credit ratings in the Basel capital adequacy proposals. The authors identify the key policy issues and provide empirical evidence on the sources and extent of rating divergencies between credit rating agencies. Their research also provides an analytical framework for examining the case of credit ratings in regulation, a subject of increasing topical importance given the need to calibrate default risk in today’s volatile credit markets