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

A risk analyst argues that a retail mortgage portfolio of 50,000 loans needs far less single-name concentration monitoring than a corporate book of 40 large loans. Which reasoning best supports this view?

The retail pool is granular, so borrower-specific (idiosyncratic) risk largely diversifies away and losses are driven mainly by systematic factors, while a 40-loan corporate book remains exposed to single-name concentration.

  1. AGranularity means idiosyncratic risk is largely diversified away in the retail pool, leaving mainly systematic risk to drive lossesCorrect
  2. BRetail borrowers have no systematic risk because their defaults are uncorrelated with the economy
  3. CRetail loans always have lower PDs than corporate loans, so concentration cannot matter
  4. DMortgage LGDs are zero because of collateral, so exposure size is irrelevant

Explanation

In a granular pool, borrower-specific risk diversifies and loss volatility is driven mostly by common factors such as unemployment and house prices. Retail defaults are not uncorrelated with the economy, PDs are not always lower, and mortgage LGDs are not zero.

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