European Union plans to increase competition in the credit ratings industry could prompt ill-equipped new entrants to offer a cut price service or higher ratings to lure customers, the sector's regulator said on Tuesday.

The sector is under the spotlight because of key failings that detractors say laid the ground of the financial crisis. It is also accused of exacerbating the euro zone's debt problems by downgrading government bonds at market sensitive moments.

The bloc's executive European Commission proposed a radical blueprint last November to try to wrestle the ratings market away from the Big Three: Moody's , Standard & Poor's and Fitch Ratings .

This would be done by mandatory rotation whereby users of ratings, such as banks, would have to switch to a competing agency after a certain period.

Verena Ross, executive director of the sector's regulatory body -- the European Securities and Markets Authority (ESMA) -- said the watchdog, which authorises all rating agencies in the EU, supported boosting competition in the sector but had some key concerns.

At least in the short term there is a risk that new entrants will come by offering higher ratings or lower prices, Ross told a webcast hearing in the European Parliament.

It is not clear, at least in the short term, they have all the necessary professional competences..., Ross said.

Sonia Van Dorp, ratings relations officer at French bank SocGen and representing the European Banking Federation, said banks were the biggest users of ratings and were typically rated simultaneously by three different agencies.

Forcing banks to switch to a national agency that is less familiar with international investors may seriously hinder European banks' financing capabilities, Van Dorp said.

QUALITY ISSUES

Markus Krall, of Roland Berger consultancy, is setting up a new European ratings agency this year and while rotation would benefit it, Krall still had concerns: Rotation is a form of queuing that will reward market participants regardless of quality and price.

Fitch's senior European counsel, Susan Launi, warned the rushed EU proposals could entrench duopoly of Moody's and S&P, which have a combined 80 percent of the market, with Fitch around 17 percent.

The draft bill, over which EU states have joint say, would give ESMA powers to examine the methodologies used by agencies. Ross said this could create serious tensions with a separate requirement for regulators not to interfere in actual ratings.

ESMA would also be required to assess market concentration of ratings agencies, another concern for ESMA as such an issue is normally looked at by a competition regulator.

ESMA would have to adopt new skills and methodologies to assess risks from market concentration. ESMA could find itself in conflicting objectives -- ensuring stability of the market and competition in the securities market, Ross said.

(Reporting by Huw Jones; Editing by Jodie Ginsberg)