Moody Õ s investors service response to the consultative paper issued by the Basel Committee on Bank Supervision ` ` A new capital adequacy framework ' '

Moody's endorses the Basel Committee's proposal to use banks' internal risk assessments to re®ne the Basel Accord's risk weights on bank assets and commitments. External risk assessments, such as Moody's credit ratings, will likely play a supporting role as direct inputs into banks' internal rating systems and as tools for benchmarking and validating those systems. However, the widespread use of ratings in regulation threatens to undermine the quality of credit over time by increasing rating shopping, decreasing rating agency independence, and reducing incentives to innovate and improve the quality of ratings. This paper discusses how bank regulators can use external ratings in ways that mitigate the adverse incentives created by the resulting regulatory demand for rating agency services. Ó 2001 Elsevier Science B.V. All rights reserved. JEL classi®cation: G11; G20; G31; G33