FRM Part II · FRM Exam Part II · Governance
A bank's credit monitoring unit observes that several borrowers in a portfolio have drawn down revolving facilities sharply, while their covenant headroom has narrowed and external ratings are unchanged. Which interpretation and action is most appropriate?
Sharp revolver drawdowns and narrowing covenant headroom are early warning indicators that often precede rating downgrades. The bank should trigger an internal review, consider watchlisting and reassess limits rather than wait for external rating changes or prematurely write off exposure.
- ATreat the unchanged external ratings as conclusive and take no action until a rating downgrade occurs
- BTreat the drawdowns and covenant erosion as early warning indicators, trigger an internal review of ratings and watchlist status, and reassess exposure limitsCorrect
- CImmediately write off the facilities because drawdowns indicate default
- DReduce monitoring frequency since utilisation rises are normal in revolving lines
Explanation
Rapid drawdowns and shrinking covenant headroom are classic early warning signals, often leading external ratings. The appropriate response is an internal review, possible watchlisting and limit reassessment. Waiting for downgrades is reactive, and write-off is premature because default has not occurred.
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