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FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management

A bank's retail mortgage portfolio and a syndicated corporate loan book both show a PD of 2% in normal times. In a severe recession, which feature most distinguishes the way losses behave and should be reflected in retail risk management?

Retail defaults still rise together when macro factors such as unemployment and house prices deteriorate. Granularity diversifies idiosyncratic risk but not systematic risk, so retail portfolios need macro-conditioned stress testing and cannot be assumed safe merely because they contain many small loans.

  1. ARetail losses are driven mainly by idiosyncratic factors, so they are unaffected by macroeconomic conditions
  2. BRetail default rates still rise with common factors such as unemployment and house prices, so portfolio diversification does not remove this systematic riskCorrect
  3. CRetail LGD is always zero because loans are small
  4. DCorporate defaults are uncorrelated while retail defaults are perfectly correlated

Explanation

Granularity removes idiosyncratic risk but not systematic risk. Unemployment and house price declines raise defaults and LGDs across the whole retail pool, so stress testing on macro factors is needed. Option A is false, C is invalid, and D overstates correlation.

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