_5_ international activities in the last decade, have devoted most of their efforts to relatively more developed economies, where marginal and fixed costs associated to the coverage of additional firms are lower and/or where the demand for ratings is higher. Second, the attainment of a worldwide scope of coverage is a very recent phenomenon, providing rating agencies with too limited a sample for comprehensive assessments of their accuracy in non-GI0 countries. Third, rating agencies tend to concentrate initially on the banking sector and only subsequently move to the non-bank sector of the economy. Finally, firms' ratings follow more closely sovereign ratings as the income level decreases. While these outcomes may be fully consistent with rational assessments of credit risk in economies with large information costs and unstable institutional structures, they also point to potential shortcomings in the use of ratings for regulatory purposes. In the Sections below, we shall try to characterize with greater detail some of these shortcomings and to assess their implication on the design of bank capital regulation.

# **3. From the distribution of ratings to that of capital requirements**

As reported in Table 3, the rule relating higher capital requirements to lower rating categories is not a monotone one and differs for banks and non-banks. The distribution of capital requirements, which is implicit in the Basel proposal, is therefore not an obvious outcome of the distribution of ratings, which we have just reviewed. In order to derive the distribution of changes in capital requirements implied in the transition from the present system to the proposed one, we have simulated the effect on the regulatory capital of a bank which would lend to the rated firms located in any single country. The exercise-based on the ratings provided by S&P-simulates the capital requirements that banks would have faced, had the proposed revision of the Capital Accord come into force in the month of November 1999. We then compare the outcome of the simulation with the current capital requirements as defined by the 1988 Capital Accord.

The 1988 regulation imposed different capital requirements according to: 1) the nature of the borrower-bank versus non-bank; 2) the location of the borrower-OECD vs. non-OECD country; 3) the maturity of the loan-less than or more than one year. To compare the 1988 regulation with the new Basel proposal effectively, we focus on the differential impact of the proposed new regulation according to the geographical location of the borrower, its economic sector (bank versus non-bank), and the maturity of loans.

Figure 2A shows the dlifferential capital requirements for all the rated non-bank corporations located in the four previously described groups of countries. Given the nature of the current regulation, which defines a specific regulatory treatment for OECD countries, we have modified the composition of the first two groups along the partition of OECD vs.non-OECD countries instead of that Gl0 vs.non-G10 countries.

For non-bank corporations, which start all from an 8 per cent requirement, there are three possible outcomes: a. decrease of 6.4 percentage points, no change, an increase of 4 percentage points. In our sample, the number of high rated corporations (better than AA), which will allow a lower capital requirement and will accordingly face a lower cost of bank credit, is equal to 581 OECD based firms and to only 15 non-OECD based firms, located in the high income category. Accordingly, no firm belonging to the two lower _Ferri, Liu, and Majnoni, "The Role of_ **_Rating_** _Agency Assessments in Less Developed Countries: Impact of the Proposed Basel Guidelines'_