Skip to content

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

A bank's retail risk team notes that during a recession the realized default rate on its credit card portfolio is well above the long-run average PD used for pricing. Which approach best addresses this when estimating capital-relevant risk parameters for retail exposures?

The best approach is to use a long-run average PD together with a downturn-conditioned LGD, complemented by stress scenarios. This captures higher loss severity in recessions and avoids procyclical estimates based on a single year's default experience.

  1. AUse only the most recent year's default rate as the PD
  2. BUse a downturn-conditioned LGD and a PD reflecting long-run average default experience, supplemented by stress scenariosCorrect
  3. CReduce the PD for accounts with high balances because they are monitored more closely
  4. DReplace PD estimation with the borrowers' average credit score

Explanation

Retail parameters should reflect long-run average PDs and downturn LGDs, since loss severity rises in recessions, with stress tests covering adverse scenarios. Using only the latest year makes estimates procyclical. Lower PDs for large balances and score averages lack a sound basis.

Did you get it right without looking?

One question tells you little. A timed set on Credit Scoring and Retail Credit Risk Management shows your real accuracy, how long you take and where you lose marks.

Practise Credit Scoring and Retail Credit Risk ManagementFree diagnostic mock

More Credit Scoring and Retail Credit Risk Management questions