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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

A bank compares its internal rating system with external agency ratings. Which statement correctly describes a typical difference that bears on the limitations of external ratings?

Internal ratings can use private borrower information and be refreshed more often, covering firms agencies do not rate, whereas external ratings are generally through-the-cycle and slower to react. This timeliness and coverage is why banks supplement agency ratings with internal systems.

  1. AInternal ratings are always point-in-time and never use borrower-specific information
  2. BInternal ratings can incorporate private borrower information and be updated more frequently, while external ratings are generally through-the-cycle and lagCorrect
  3. CExternal ratings are updated more frequently than any internal system
  4. DExternal ratings are available for nearly all small and medium-sized borrowers

Explanation

Banks hold private information on borrowers and can update internal ratings often, so they can be more timely and cover unrated small and medium firms. External ratings tend to be through-the-cycle and slower. Many small borrowers have no external rating, so the other statements are wrong.

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