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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

During a recession, a bank's portfolio is rated using a point-in-time (PIT) system and, separately, a through-the-cycle (TTC) system. Which outcome is most consistent with the known properties of these systems?

Point-in-time based capital would rise more sharply in a recession. PIT ratings react quickly to worsening conditions, producing fast downgrades and higher estimated default probabilities, which makes capital requirements procyclical. Through-the-cycle ratings are stable and so generate smaller capital swings over the cycle.

  1. APIT-based regulatory capital would be expected to rise more sharply than TTC-based capital because PIT ratings migrate downward fasterCorrect
  2. BTTC-based capital would be expected to rise more sharply than PIT-based capital because TTC ratings are more volatile
  3. CBoth systems would produce identical capital requirements because default probabilities are unchanged
  4. DPIT-based capital would fall because current conditions make borrowers appear safer

Explanation

PIT ratings respond to deteriorating conditions, so downgrades and higher PDs arrive quickly, raising capital requirements and making them procyclical. TTC ratings are stable, so capital changes less. The option claiming TTC is more volatile reverses this relationship.

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