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

A bank uses a point-in-time (PIT) internal rating system. During a sharp economic downturn, which outcome is most likely compared with a through-the-cycle system?

Under a point-in-time system, a downturn produces more downgrades because ratings reflect current conditions, while each grade's PD stays roughly constant. Portfolios shift into riskier grades, so rating-based capital requirements rise, making the system more procyclical than a through-the-cycle approach.

  1. ARating migration matrices show fewer downgrades and the PD of each grade stays roughly constant
  2. BRating migration matrices show more downgrades, and the PD assigned to each grade stays roughly constant, so regulatory capital based on the ratings is more procyclicalCorrect
  3. CRating migration matrices show fewer downgrades and the PD of each grade falls
  4. DRating migration matrices are unaffected and capital requirements fall

Explanation

PIT ratings respond to current conditions, so obligors are downgraded in downturns. Each grade's PD is stable because the movement is captured by migration between grades. Capital linked to ratings therefore rises in downturns, increasing procyclicality. Option A describes TTC behaviour.

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