International Finance Regulation: The Quest for Financial Stability

CHAPTER 11 Rating Agencies and Auditors

“The regulatory landscape for rating agencies has been irrevocably changed. Governments have put in place many new rules and regulations to address the issues that led to the crisis. Rating agencies are subject to regulatory controls that did not exist before.”

—Standard & Poor's President Doug Peterson

It might be surprising to some that rating agencies and external auditors are put in one category. It is not just because they both miserably failed to identify the weaknesses of financial institutions. Their role in the financial world is arguably even more important than in other industries.

Their function is to provide some form of assurance and valuation of the quality of the financial structure (rating agencies) and the accounts (auditors). They pass a judgment that is supposed to have two characteristics: independence and objectivity. As such, by giving a rating to a bank or approving their accounts, they give guidance to investors and regulators, clients, and depositors. Or at least we thought so until things appeared very different than the reality.

PART I: THE RATING AGENCIES

The rating of banks and financial instruments was influenced by a number of elements. At the bottom of this, three realities emerged from the financial crisis.

1. Their competition was deadly and led to price cuttings, and the quality and the quantity of their work was affected.
2. The fact that they were paid by those they had to judge was creating a strange ...