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FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment

A bank's scorecard was developed on data from an expansion period with low defaults. During a downturn, the model's ranking of borrowers remains good, but the observed default rate in every score band is well above the predicted rate. Which assessment is most appropriate?

Discriminatory power remains intact because borrowers are still ranked correctly, but calibration is poor since predicted default rates are consistently too low. The appropriate response is recalibrating the probabilities to current or downturn conditions rather than concluding the model cannot rank risk.

  1. ADiscriminatory power is intact but calibration is poor, so probabilities should be recalibrated to reflect the downturnCorrect
  2. BDiscriminatory power is poor, so the model should be rebuilt with new predictors
  3. CBoth discrimination and calibration are acceptable because ranking is preserved
  4. DThe model is overfitted, so the sample size should be reduced

Explanation

Good ranking means discrimination (e.g., AUC) is preserved. Systematically underpredicted default rates in all bands indicate a calibration failure caused by the change in the cycle. The fix is recalibrating PDs, not necessarily rebuilding the model.

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