Study On The Regulation On China’s Credit Rating Industry

Credit rating agencies are regarded as the proctector of investors and thegatekeeper of financial markets, and its positive role of resolving the marketinformation asymetry is widely confirmed by the market and the regulatory body. Butthe quality of credit rating is descending. The southeast Asian financial crisis in1997and the Anron Scandal in2001cause the public to worry about the information valueof credit rating. The American subprime mortgage crisis happened in2007provokedintense critisim of credit rating agencies. Because of the important role of crdit ratingindustry and its bad performance, it is very important to increase the regulation on thecredit rating industry.In my view, the regulation on the credit rating industry is composed of two partsincluding official regulation and reputation mechanism, so accordingly the researchon China’s credit rating industry is arranged by the two main lines.Official regulationcan fix the problem of market failure and overcome the market defect which can notbe solved by itself. Reputation mechanism is a type of self discipline. It promotes thecredit rating agencies to provide high quality service and product, which is theimportant security to make the credit rating industry work effectively. Meantimereputation mechanism can close the door to interest group capture of the regulatorybody. So the official regulation and the reputation mechanism should combineeffectively to maintain the healthy and orderly development of the credit ratingindustry.There exist negative externality, natural monopoly, information asymmetry andconflict of interests in credit rating industry. These features cause the market failure.So the official regulation is needed to fix the problem. Reputation mechanism isimportant as well not only because of the features of the credit rating industry, butalso its role of supplement to official regulation. The Dittrich model is displayed toexplain how the reputation mechanism works. Four external conditions are essentialto make the reputation work well including the repeated transactions, appropriatecompetition structure, penalties on misconduction and the long-time expectation onrepuatation.Initially America’s credit rating industry completely relied on reputationmechanism. And then it relies mainly on reputation while making officialsupervision subsidiary. The Credit Rating Act in2006identies the direct regulationpower of SEC. The subprime mortgage crisis induces the issue of Dodd-frank Act, which perfects the regulation on credit rating industry. So the analyze on the historyand current situation of credit rating industry and its regulation is useful for China tolearn lessons. Different from American’s style, China’s regulation on credit ratingindustry develops from the phase of single regulatory body to that of multipleregulatory bodies and layers. Based on deep researches on the currect situation ofregulation on China’s credit raing industry, it can be concluded that there existdefects in two ways. On the one hand is the problems in official regulation, includingthe unreasonable recognition, the flawed management on conflicts of interest and theunsoundness of information disclosure. On the other hand is the problems in thefunction of the reputation mechanism, including the unsondness of distinguishmechanism, the ureasonable competition structure and the incorrect benefitmotivation.Further, based on the above analysis, led by the problems of China’s officalregulation of credit rating industry the study on the construction of offcial regulationof credit rating industry is developed. The game theory is used to analyze the actionsof credit rating agency and regulatory body following the order of static game,evolutionary game and dynamic game. And based on the feature of multipleregulatory bodies in China’s credit rating industry, the researches are conducted toget the optimal regulation level and the conditions to meet Nash equilibrium ofoptimal regulation.Because of the important role of reputation mechanism, this paper anaylzes thereputation effect of China’s credit rating industry from the theoretical aspect and theempirical aspect. Because our credit rating industry is motivated by the government,which is different from American’s, the feasibility of reputation mechanism isidentified, that is whehther the base of repuatation mechanism exists. After that, theempirical studies is developed. The result shows that the effect of reputation exists,but the intensity is limited.Based on the above analysis, the policies are proposed to strengthen the officialregulation and reputation discdipline. To strengthen the official regulation, it needs tobuild the only regulatory body, optimize the recognition mechanism, enhance themanagement on conflicts of interests and introduce unsolicited rating mechanism. Tostrengthen the reputation discipline, it needs to improve the effectiveness ofinformation disclosure, promote the acting role of industry association, decrease therating-based regulation and build the market exit mechanism.