Banks and asset managers must form an opinion on their own credit standing to avoid relying completely on rating agencies, Bank of England Deputy Governor Paul Tucker said on Monday.
Tucker said it was immensely important that the authorities reduce, if possible eliminate, mechanistic reliance on rating agencies at banks and investment firms.
Always have your own view, he told a Goldman Sachs seminar on the European Union's European Securities and Markets Authority (ESMA).
Securities regulators can play an important role in policing this across the world as they supervise many asset managers, Tucker added.
ESMA has become the lead supervisor for rating agencies such as Moody's, Standard & Poor's and Fitch in the 27-nation bloc.
Banks use ratings to calculate how much capital they should have in their regulatory buffers, while asset managers are forced to sell some assets whose ratings dip below a certain threshold.
Such a reliance can cause big, sudden shifts in markets and capital requirements and exacerbate down cycles, critics say.
A requirement for financial firms to carry out their own due diligence is part of a draft EU law to reshape a sector dominated by the Big Three.
Many policymakers accuse the agencies of exacerbating the euro zone debt crisis by downgrading the sovereign debt of countries like Greece, France and Italy at sensitive times.
But ESMA Chairman Steven Maijoor sent a shot across the bows of politicians, saying the watchdog won't interfere in actual credit opinions.
ESMA will not interfere with the content or methodology of the ratings. It's important as supervisors we focus on the other stuff, Maijoor told the seminar, giving examples such as governance, independence and transparency.
There is an obligation on all public authorities across the EU not to interfere with ratings, Maijoor added.
Ratings agencies have warned that the European Union's plans to reform the sector through rotation of agencies to boost competition will force users to obtain ratings from agencies that are not familiar to international investors.
Andrew Tyrie, chairman of the UK parliament's influential treasury committee, echoed this unease, saying, I don't think we need to act vigorously now. I would rather take time and get it right.
GLOBAL MINIMUM MARGIN
Tucker said securities regulators like ESMA should embrace financial stability as part of their remit, a consideration that marks a departure from decades of regulation.
There will also probably need to be minimum margin requirements around the world on banks and other financial actors to make the system safer, said Tucker, a member of the Financial Stability Board, a regulatory task force for the world's group of top 20 economies (G20).
Clearing houses, which collect margins, should also have resolution regimes since their failure would bring mayhem to capital markets, he added.
But Tucker said it was a misconception that the Bank would be unwilling to extend liquidity lines to a clearing house in trouble.
Instead, central banks should not commit in advance to providing such help and there should be no obstacle to doing so if required, Tucker said.
This is a policy we completely embrace, Tucker said.
A core role of ESMA is to create a single rulebook in the European Union to provide consumers and firms with a consistent supervisory approach; Maijoor said it should be replicated across the world through mutual recognition of rules that are equivalent.
(Reporting by Huw Jones; editing by Andrea Evans)