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FRM Part II · FRM Exam Part II · Credit Scoring and Rating

A bank is designing its internal ratings-based (IRB) rating system for corporate exposures. The risk committee asks how the rating system must be structured so that it meets Basel expectations for obligor and facility assessment. Which design feature is most consistent with Basel IRB requirements?

Basel IRB expects the rating system to assess obligor default risk separately from facility-specific features such as collateral and seniority, which drive loss severity. Meaningful differentiation of risk and periodic review are required, so single grades, mechanical reliance on agency ratings, or static ratings are not acceptable.

  1. AA single rating grade for all exposures to avoid over-segmentation
  2. BA separate assessment of obligor default risk and facility-specific loss severity featuresCorrect
  3. CRating assignments based solely on external agency ratings with no internal override
  4. DRating grades assigned only at origination and never revisited

Explanation

Basel IRB requires a two-dimensional approach: borrower risk (PD) is assessed separately from transaction-specific factors such as collateral and seniority (LGD/EAD). A single grade, pure reliance on external ratings, or static ratings all fail the requirements for meaningful differentiation and regular review.

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