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

A bank's risk committee is comparing its credit card portfolio of 400,000 small balances with a book of 40 large corporate loans. Which statement best describes how the bank should typically assess and manage credit risk in the two portfolios?

Retail credit risk is managed at portfolio level with statistical scorecards and pooled loss estimates because exposures are numerous, small and homogeneous. Corporate credit risk is assessed obligor by obligor with financial analysis and judgmental ratings because exposures are few and large.

  1. ARetail risk is managed at portfolio level using statistical scoring and pooled loss estimates, while corporate risk is assessed borrower by borrower using financial analysis and judgmental ratingsCorrect
  2. BRetail risk is managed borrower by borrower with individual covenant negotiation, while corporate risk is managed using pooled statistical scorecards
  3. CBoth portfolios are best managed through individual analyst review because each borrower's default is unique
  4. DBoth portfolios should rely solely on market-implied default probabilities from traded bond spreads

Explanation

Retail portfolios consist of many small, homogeneous exposures, so decisions are automated through scorecards and losses are estimated for pools. Corporate exposures are few and large, so analysts review each obligor's financials and assign judgmental ratings. Option B reverses the approaches. Retail borrowers rarely have traded bonds, so market-implied spreads are not available.

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