FRM Part II · FRM Exam Part II · Credit Scoring and Rating
A bank's internal rating system is described as point-in-time, while a rating agency's scale is through-the-cycle. During a sharp economic downturn, which pattern would a risk manager most likely observe?
The bank's point-in-time internal ratings would show larger and faster downgrades in a downturn, making capital requirements more procyclical. Agency through-the-cycle ratings are smoothed to look through the cycle, so they migrate less. Therefore the internal system is the more volatile one.
- AAgency ratings migrate more than the bank's internal ratings
- BThe bank's internal ratings show larger downgrades and more procyclical capital requirements than agency ratingsCorrect
- CBoth systems show identical migration because they rate the same obligors
- DInternal ratings stay unchanged while agency default rates rise sharply
Explanation
Point-in-time ratings incorporate current conditions, so obligors are downgraded quickly in a downturn, raising risk-weighted assets and capital requirements (procyclicality). Through-the-cycle ratings are smoothed and move less. The option claiming agency ratings migrate more reverses the philosophies.
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