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

A bank's credit risk team is reviewing its internal rating system. The rating scale assigns each borrower a grade and each facility a separate loss-severity measure. Under the Basel internal ratings-based (IRB) framework, which pair of rating dimensions does this two-dimensional structure correspond to?

The two dimensions are a borrower grade reflecting probability of default and a facility-level estimate of loss given default. Basel IRB requires separating obligor risk from transaction-specific risk, so PD and LGD are the standard pairing rather than spreads, maturity buckets or country grades.

  1. ABorrower probability of default (PD) grade and facility loss given default (LGD) estimateCorrect
  2. BBorrower credit spread grade and facility maturity bucket
  3. CFacility collateral grade and borrower country grade
  4. DBorrower equity volatility grade and facility coupon grade

Explanation

Basel IRB expects a two-dimensional rating system: one dimension reflects borrower risk (probability of default) and the other reflects transaction-specific factors (loss severity, LGD). The other options mix in elements that are not the standard two dimensions.

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