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CMA Final · Risk Management in Banking and Insurance · Credit Risk Management

Which statement about the difference between expected loss and unexpected loss in credit risk management is correct?

Expected loss is the average anticipated loss and is handled through pricing and provisions, whereas unexpected loss is the volatility around that average and is covered by capital. The reverse statements misassign the roles of provisions and capital.

  1. AExpected loss is normally covered by provisions and pricing, while capital is held mainly against unexpected lossCorrect
  2. BUnexpected loss is covered by loan-loss provisions and expected loss by economic capital
  3. CBoth are covered only by capital with no role for pricing
  4. DExpected loss is the volatility of losses and unexpected loss is the average loss

Explanation

Expected loss is the average anticipated loss, built into loan pricing and provisions. Unexpected loss is the variability of losses around that average, and capital acts as the buffer for it. The other options reverse or confuse these roles.

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