US ratings agency Standard & Poor's last week warned international regulators that it might not support proposals which would aim to make the company's credit assessments a cornerstone of sweeping regulatory reforms.

As part of the overhaul, the Basle Committee on Banking Supervision, headed by William McDonough, is proposing fundamental changes to the way banks calculate how much capital they have to set aside to cushion themselves against unexpected credit losses should a borrower or counterparty default. Specifically, the Basle Committee is recommending that banks set aside capital according to the credit rating of the underlying exposure, be it a borrower or trade counterparty. The new rules will impact on almost every corner of the debt and credit markets, from plain vanilla government bond trading to highly structured loan securitisations. In an official letter to the committee, the agency said last week that the rules would improve disclosure and reduce the likelihood of a systemic banking failure. But it warned that it would not be party to them if the price was greater regulatory intervention in its own business. Barbara Ridpath, chief criteria officer at the agency's European headquarters, said: "If we feel that as a result of new regulations, our independence might be compromised, then we might possibly reserve the right to decline to be regulated.' The agency is particularly concerned that its track record might in future be the subject of supervisory scrutiny, as well as the proprietary analysis it makes to set its ratings. It also seems likely that regulators will require the agency to make much of the data it has complied over the years, freely available to market participants. Although the ratings agencies were not told in advance of the committee's intention to draw so heavily on their own analysis, S&P's response is, nevertheless, at odds with perceptions that the agencies would wholeheartedly embrace the new system. Ridpath says: "For the moment, we are not entirely sure that we have a role to play in all this. For example, we don't think that banks should adopt our own credit assessments at the expense of developing their own risk management procedures.'The agency is also worried that its ratings approach might not be fully understood, either within the committee or among some of the banks which might eventually be required to accept its methodology. For example, the current proposals appear to imply that a sovereign borrower rated AAA is less likely to default than a company with the same rating – an assumption that the agency hotly refutes. Moreover, under the grading system mooted by the Basle Committee, a bank which has an exposure to a corporate client rated AA- must increase the capital it holds fivefold if that company is subsequently downgraded to A+. Yet the probability of default scarcely changes at all. S&P's controversial response to the Basle proposals will add grist to the argument that banks should be allowed to use their own assessments rather than those supplied by outside ratings agencies. But while the banks argue that they can better manage credit risk using state-of-the-art computer software, the Basle Committee has indicated that, save for a handful of exceptions, the industry will be required to adopt the agencies' ratings. A number of trade associations, including the British Bankers' Association and the International Swaps and Derivatives Association, are not thought likely to be ready with their responses until closer to the March 31 deadline. "We want to make sure that there is a dialogue before the final proposals are set in stone. We certainly don't want the regulators to hold us to something which, in the future, might be untenable,' Ridpath says.