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2). These reforms are intended as reassurances to nervous European consumers and investors to prevent future financial crises (Hughes & Augier, 2014).
Recent changes to CRA regulations. In the United States, number of issues that may affect investors may be unregulated to some extent absent further regulatory or legislative action including the unregulated nature of the methodology used by CRAs (Mierzwinski & Chester, 2007). In the European Union, though, revised rules adopted in May 2013 included mandatory rotation of CRAs and approval of the methodology they use in assigning credit ratings (Update on regulation of credit rating agencies, 2013).
Credit Rating Agency Reform Act of 2006. In 2006, Congress passed the Credit Rating Agency Reform Act that required the U.S. Securities and Exchange Commission (SEC) to promulgate clear guidelines to identify credit rating agencies that would qualify as Nationally Recognized Statistical Rating Organizations (NRSROs) (Credit reporting agencies, 2014). The Credit Rating Agency Reform Act also authorized the SEC to regulate NRSRO internal processes concerning record-keeping practices, guidelines for preventing conflicts of interest, and established the protocol whereby NRSRO determinations were subject to review (Credit reporting agencies, 2014). It is important to note, though, that the Credit Rating Agency Reform Act specifically prohibits the SEC from regulating the rating methodologies used by NRSROs (Credit reporting agencies, 2014).
After the 2008 housing bubble. Credit rating agencies use a business model that is characterized by a fundamental conflict of interests (New rules will fail to reform ratings agencies, 2014). In a painful reminder that greed can infect an entire industry, the 2008 housing bubble focused attention squarely on the CRA sector. According to Baker (2008), prior to the 2008 housing bubble burst, “Banks paid for the rating of their bonds by credit agencies,” a practice that “should have prompted more concern from regulators” (2008, p. 73). These lax practices resulted in enormous profiteering at the expense of the American taxpayer. In this regard, Baker notes that, “This situation was a recipe for abuse” (2008, p. 73). Indeed, a representative from Standard and Poor’s emphasized that, “Securities backed by faulty mortgages were an ‘epicenter’ of the crisis, leading investors astray by ‘wrapping serious financial risks in a thin veneer of creditworthiness (cited in Regulators OK overhaul of credit rating agencies, 2014, p. 3). Prior to the 2008 housing bubble burst, investment bankers and securities issuers practiced what is known as “ratings shopping” and hired the CRA that would provide them with the most advantageous ratings (New rules will fail to reform ratings agencies, 2014). Although regulators have encouraged CRAs to offer unsolicited ratings on issuances they have not been hired to rate, ratings shopping has been revived (New rules will fail to reform ratings agencies, 2014).
Most industry analysts agree that the CRAs were responsible for causing the financial crisis, with the overarching motivation being greed (New rules will fail to reform ratings agencies, 2014). For instance, one analyst suggests that, “Financial institutions that created residential mortgage-backed securities (RMBS) needed strong CRA ratings in order to sell their financial products, since many investors…
Credit Risk Management Banks are an important part of the economy of any nation. Traditionally, the banks operate as financial intermediaries serving to satisfy the demand of people in need of various forms of financing. Through this, banks enable people to purchase home and businesses to expand. These financial institutions therefore facilitate investment and spending that are responsible for fueling the growth of the economy. In spite of their vital role
Finance Question 1.a) Bond ratings encompass a wide range of elements related to the credit risk of the firm. Moody's notes that bond ratings include elements of default probability, loss severity, "financial strength" and "transition risk" (Cantor & Fons, 1999). The authors note that within the same sector, bonds of the same rating tend to be comparable both with respect to overall credit quality and specific credit quality characteristics. Over different
Accts Receivable Accounts receivable reflects credit that has been extended to customers. The positive aspect is that it represents a sale that has been made; the negative is that it represents a sale that has not been paid for. There are a number of benefits to extending credit, but there also drawbacks. Thus, companies need to pay special attention to how they manage their accounts receivable. Effectively management of accounts receivable can
Social Credit Score in the US?IntroductionThe concept of a social credit score system has garnered significant attention due to its implementation in countries like China. This system evaluates citizens based on their behavior, trustworthiness, and societal contributions. The research topic at hand delves into the potential implications of introducing such a system in the US, specifically asking: What are the potential impacts for society and for public administration of introducing
Improving the Administration and Collection Process for Government-Sponsored Student Loans Introduction Today, tens of thousands of young people are mortgaging part of their future with student loans in order to obtain a higher education. In some cases, these students do not receive the full disclosure concerning repayment terms, creating a long-term hardship. To determine the facts, this paper provides an overview of government student loans and how the different actors on the
The philosophy behind Frank-Dodd is to minimize the risk to the taxpayer of trade in these instruments, but this is to be balanced against the needs of the industry. Arguably, however, there is no particular need for synthetic CDOs, so tight regulation that restricts their manufacture and use should be sufficient. The Frank-Dodd Act imposes significant regulatory burden on synthetic CDOs and the use of credit default swaps to create