Digitizing the Credit Rating System

If it is not absurd to talk about digital money, it certainly isn’t absurd to talk about digital credit ratings. In fact, there are good reasons to move towards a digital credit rating system sooner rather than later. Here are three:-

  1. Digital talks to machines as well as people. With the rise of blockchain-based exchanges the demand for digital ratings should begin to resemble Moore’s Law.
  2. Digital promotes diversity–individually and socially. It is blind to the gender and race of the obligor, and to the power of the client institution.
  3. Digital is more dependable and efficient than human for data processing. McKinsey (2016) estimates up to 78% of repeatable data processing work can be automated. Credit ratings have an enormous potential to make their products cheaper, less error-prone and more robust by automating repeatable data-intensive processes.

Since the 1970s, finance has moved inexorably towards data. The model of finance has shifted from a focus on going-concern corporations to trading. Organized derivatives and equities exchanges have been responding to the new dynamic market order since the 1980s, first with real-time margining and then automated trade infrastructure. Only the OTC credit markets lag far behind. Their benchmarking function is provided by government-designated CRAs (NRSROs) shielded from competition.

The higher-order data decision process of NRSROs is still an antiquated jury system.

Digital money is here to stay. The peak of a global Credit Crisis marked its inflection point from shady to mainstream. That a non-government backed, market-based currency has gained acceptance by respectable institutions is remarkable. But it is more than a testimony to financial system innovativeness. It signifies a broken global credit system, due in no small part to a primitive and gameable credit price-benchmarking system.

Primitive and gameable has situational advantages for sophisticated market players. However, a broken credit system serves no one. It means the economy is out of control, literally. Central banks attempting to bring it under control with liquidity are only making it worse. As surely as interest is the obverse of principal, liquidity is the opposite of credit.

The economy can grow itself into sustainability only with strict rationing of access to future money based on continuously-monitored repayment ability. The technology to do this is digital–it exists–but wherever the prospect is painful, the political will is weak. And so, we agree to keep adding liquidity to the market, hoping that “this time it will be different,” knowing it won’t.

There is a way out: expand credit ratings to serve the market of under- or unbanked assets between $10 and $65 TN, and growing with the pandemic. Digital ratings can’t change a firm’s creditworthiness, but they can change the economics of ratings and shed light on value that is not obvious under the current credit regime–for no justifiable reason.