Market Power in the Credit Rating Industry: State of Play and Proposal for Reforms

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Bertrand Candelon, Axel Gautier, Nicolas Petit, Jan 28, 2014

In recent years, the Credit Rating Agencies have been in the eye of the storm. Some argue that CRA rating errors-symptomatized by rating inflation or deflation-originate in excessive competition. This paper argues that the low level of competition in credit rating is a better explanation for rating this phenomenon.

To show this, the present paper is divided in seven sections. Section II gives a brief overview of the credit rating industry. Section III describes CRAs rating errors, focusing on rating inflation and deflation. Section IV argues that the cause of rating inflation and deflation is due to CRAs’ significant market power, in a sector where the process of competition by reputation fails to work. Section V looks at structural features of the industry specifically in the context of conflicts of interests. Section VI argues that more competition in credit rating services is warranted, reviews recent regulatory changes that purport to promote competition, and offers additional suggestions for reform, while Section VII concludes.