Skip to content

FRM Part II · FRM Exam Part II · Credit Risk Management

Under a credit support arrangement, a bank requires a borrower to post additional collateral whenever the borrower's credit rating falls below a stated level. What is the main risk of relying on such a rating-based trigger as the principal mitigant?

The main risk is that the extra collateral call occurs when the borrower is already stressed, worsening its liquidity and possibly triggering default. Rating triggers are procyclical and do not remove wrong-way risk or legal issues.

  1. AThe additional collateral demand can arise just when the borrower is already stressed, accelerating its liquidity problems and the potential for defaultCorrect
  2. BThe trigger eliminates the bank's wrong-way risk entirely
  3. CIt reduces the bank's legal certainty over the collateral
  4. DIt makes the exposure insensitive to market movements

Explanation

Rating triggers are procyclical: calls come when the borrower is weakest and liquidity is scarce, which can precipitate the very default being mitigated. They do not eliminate wrong-way risk, and they do not alter legal certainty or make exposure insensitive to market moves.

Did you get it right without looking?

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

Practise Credit Risk ManagementFree diagnostic mock

More Credit Risk Management questions