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FRM Part II · FRM Exam Part II · Governance

Which underwriting practice best reflects sound credit-granting standards for a new commercial loan?

Sound underwriting assesses the borrower's cash-flow repayment capacity as the primary source of repayment, with collateral serving only as a secondary source. Relying on collateral, cross-selling prospects or an old rating ignores whether the borrower can actually service the debt from operations.

  1. ARelying primarily on collateral value so that repayment capacity need not be analyzed
  2. BAssessing the borrower's cash-flow repayment capacity as the primary source of repayment, with collateral as a secondary sourceCorrect
  3. CBasing approval on the relationship's expected cross-selling revenue
  4. DApproving based on the borrower's historical rating without considering the loan purpose

Explanation

Sound underwriting focuses first on the borrower's ability to repay from cash flow, using collateral and guarantees as secondary protection. Relying on collateral alone, cross-selling revenue or stale ratings ignores the primary repayment source and the loan's purpose.

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