The Role of Rating Agencies: Implications for the Financial System and Central Banks’ Efforts to Reduce their Reliance

The financial crises of 2008 and 2010–11 have led regulators to seek ways to reduce mechanistic reliance on rating agencies: rating actions, and in particular sovereign downgrades, heavily affect the financial system—especially banks—and the real economy, also due to the existence of a ‘sovereign ceiling’ for domestic issuers. We analyse first the channels by which sovereign downgrades have an impact on sovereigns themselves, on banks and other financial institutions, on non-financial firms and, ultimately, on the real economy. After explaining why the Eurosystem needs credit ratings for monetary policy implementation and describing the way ratings are ‘hardwired’ in the Eurosystem’s and other major central banks’ collateral frameworks—most of the financial risks borne by the Eurosystem’s balance sheet arise from assets assessed by rating agencies—we provide an overview of the recent academic and policy debate, in particular of those authors who encourage the Eurosystem to end the use of agencies’ sovereign ratings and rely instead on the assessment of sovereign risk developed internally or provided by another European public institution. In the last section, we examine the extent to which the Eurosystem has so far reduced its reliance on rating agencies.