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FRM Part II · FRM Exam Part II · Basel III: Finalising Post-crisis Reforms

Under the revised standardised approach for credit risk, which statement about the use of external credit ratings is correct?

Banks must perform due diligence on externally rated exposures and apply a higher risk weight if that analysis shows greater risk than the rating implies. Due diligence can never be used to reduce the rating-based risk weight.

  1. ABanks must rely solely on external ratings for all exposures in every jurisdiction
  2. BBanks must conduct due diligence to ensure external ratings appropriately reflect creditworthiness, and must assign a higher risk weight if due diligence reveals greater riskCorrect
  3. CDue diligence may lower the risk weight below that implied by the external rating
  4. DRatings may be used only for sovereign exposures

Explanation

The finalised framework requires banks to perform due diligence on externally rated exposures; if it shows higher risk than the rating implies, the bank must apply a higher risk weight. Due diligence cannot be used to assign a lower weight than the rating-based one.

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