The International Monetary Fund (IMF) has come out in favor of increased regulation of the rating agencies. Their decision was made public in a report and was in reaction to the recent escalation of European sovereign credit risk. The IMF’s opinion was directed specifically at Moody’s, Fitch, and Standard & Poor’s, the only three agencies with a worldwide presence.
“In general, ratings are fairly accurate in foretelling when a sovereign is likely to default, though more attention to sovereign debt composition and contingent liabilities could help improve their rating,” said the IMF.
However the report complained that, “Ratings are embedded in various rules, regulations and triggers, so that downgrades can lead to destabilizing knock-on and spillover effects in financial markets.” A downgrade can lead to a sell-off that drives down the value of the affected country’s bonds, increases the cost of borrowing in the future, and imposes strain on government’s finances.
IMF recommended that policymakers should “wherever possible remove or replace references to ratings in laws and regulations, and in central bank collateral policies.”