The Office of the Comptroller of the Currency finalized a rule prohibiting banks from relying on credit ratings agencies to determine whether a security is “investment grade.”
The rule comes under the Dodd-Frank Act and effectively eliminates references to credit ratings agencies in OCC regulations. It will go into effect Jan. 1, 2013.
The largest firms Fitch Ratings, Standard & Poor’s, and Moody’s Investors Service (MCO) took backlash after the financial crisis for rating bonds backed by risky mortgages as the highest grade, AAA.
Many of the largest institutional investors and funds will not invest in a security unless a large ratings agency stamps the bond as “investment grade,” widely defined as BBB and up.
Banks are allowed to lean on other sources of information to determine the grade of the security, including third-party analytics or their own systems.
“Consistent with existing rules and guidance, an institution should supplement any consideration of external ratings with due diligence processes and additional analyses that are appropriate for the institution’s risk profile and for the size and complexity of the instrument,” the OCC said.
Community banks complained because of the new requirements, larger firms with more sophisticated systems and more resources would hold an unfair advantage in the securities market. Also, the larger banks said foreign institutions would hold an edge because they could still rely on credit ratings agencies.