The financial crisis of 2007-2008 : the role of credit rating agencies in the crisis and the regulation of the sector in the European Union

Abstract

Credit rating agencies play an important role in modern financial markets. This thesis treats the manner in which credit rating agencies may have contributed to the current worldwide financial crisis and the recent attempts to make them accountable. The first chapter commences by tracing the historical evolution of credit rating agencies, the reason for their inception in the United States of America and their subsequent evolution in this continent, as well as their later introduction in Europe, where at first, they were considered alien. It then proceeds to provide an overview of the functions that credit rating agencies perform in the wider economy and in financial markets in general, the purpose and methodology of credit ratings and why ratings are required. It also deals with the structure of credit rating agencies and how they operate as well as their changing role, and, finally, the emerging control of the operation of credit rating agencies by policy-makers in the USA and elsewhere around the world. Chapter two attempts to illustrate the role of credit rating agencies in the credit crisis of 2007 and 2008, most importantly their role in failing to identify the shortcomings of their risk assessment models, and attempts to analyse whether rating agencies added 'fuel to the fire' in this crisis. It explains the concept of 'securitization' and the main areas of friction inherent therein, the role of securitization and the credit rating process in the 2007-2008 financial crisis, and, finally, the conflicts of interest of credit rating agencies and model inaccuracy of credit ratings. In chapter three an analysis of the EU Regulation on Credit Rating Agencies, promulgated in April 2009, is conducted, examining how the EU aims to regulate this sector, and further compares the Regulation with United States legislation and IOSCO guidelines. The fourth and final chapter will conclude by focusing on the overall impact that the Credit Crisis has had on credit rating agencies in the EU, the impact of the Regulation and how, or to what extent, this will have an effect upon the business and operation of credit rating agencies in Europe.