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Free Questions › FRM › Credit Risk Measurement and Management
Free FRM Credit Risk Measurement and Management Practice Questions & Answers
400 exam-style Credit Risk Measurement and Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 391
The 'procyclicality mitigation' features introduced in Basel III for credit risk capital include which of the following?
Select an option first.
Correct answer: B — Countercyclical capital buffer, forward-looking IFRS 9 provisioning, through-the-cycle PD calibration in IRB, and conservation buffer with distribution restrictions.
Explanation: Basel III procyclicality mitigants: (1) CCyB: accumulate in booms, release in downturns; (2) Conservation buffer: restricts distributions when eroded; (3) TTC calibration: stable PDs resist cyclical amplification; (4) IFRS 9 forward-looking ECL: earlier, smoother provisioning. A (PIT in IRB) increases procyclicality; C and D are wrong.
Question 392
In the 'loan workout' process for a defaulted credit, the bank aims to:
Select an option first.
Correct answer: B — Maximise recovery by working with the borrower on a restructuring plan (debt modification, asset sales, equity injection) or pursuing legal enforcement as appropriate.
Explanation: Workout process: after default, the bank's special assets/workout team works to: (1) stabilise the borrower (temporary forbearance, covenant waiver); (2) develop a restructuring plan (extend maturity, reduce rate, convert portion to equity, covenant reset); (3) if restructuring fails, pursue enforcement (collateral seizure, insolvency). The goal is to maximise NPV recovery. A crystallises loss unnecessarily; C and D are incorrect defaults.
Question 393
A bank uses 'Expected Credit Loss' provisioning under IFRS 9. During an economic expansion, ECL provisions are likely to:
Select an option first.
Correct answer: B — Decline as PDs fall and macroeconomic overlays become more optimistic, reducing the forward-looking expected loss estimate.
Explanation: IFRS 9 ECL is PIT and forward-looking: in an expansion, (1) PIT PDs fall (borrowers performing well), (2) macro overlays are optimistic, (3) LGDs may fall (collateral values rising). ECL provisions therefore decline. This creates some procyclicality relative to the old incurred loss model. A, C, D are incorrect.
Question 394
Which of the following best explains why credit risk management at a bank requires an 'independent' credit risk function separate from the originating business line?
Select an option first.
Correct answer: B — To avoid conflicts of interest — originating business lines face revenue pressure to approve loans that may not meet credit standards, while an independent function can objectively evaluate and challenge credit decisions.
Explanation: Independence is critical: without it, relationship managers optimise for client relationships and fee income, potentially approving credits that are too risky. Independent credit review (second line of defence) evaluates credits objectively, can override or escalate borderline decisions, and reports directly to the CRO. A, C, D either oversimplify or mischaracterise the rationale.
Question 395
The 'expected positive exposure' (EPE) of a derivative portfolio is the primary input for calculating:
Select an option first.
Correct answer: B — CVA and counterparty credit risk (CCR) capital — EPE measures the average positive (credit-exposing) MTM value of the portfolio over the life of the contract, considering the possibility of MTM being positive or negative.
Explanation: EPE = time-average of expected exposure E[max(MTM, 0)] over the simulation horizon. It is the key input to: (1) CVA = integral of EPE × Hazard rate × LGD; (2) CCR capital = EPE × supervisory alpha (1.4) = 'Effective EPE × 1.4' for IMM approach. A is VaR; C is DV01; D is OpRisk.
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Question 396
A bank's credit risk stress test shows that under a severe recession scenario, CET1 would fall from 13% to 7.5%. Given the regulatory minimum of 4.5% and conservation buffer of 2.5%, the bank:
Select an option first.
Correct answer: B — Has entered the conservation buffer zone (7.0-9.0%) — distribution restrictions activate but the regulatory minimum (4.5%) has not been breached. Regulators may require capital recovery plans.
Explanation: Analysis: regulatory minimum = 4.5%; conservation buffer bottom = 7.0%. At 7.5% CET1, the bank is within the conservation buffer (7.0%-9.0%). Distribution restrictions apply. But it has NOT breached the 4.5% minimum (A). Immediate equity issuance may be required by supervisors but is not automatic. C and D are not automatic consequences.
Question 397
The 'IFRS 9 staging assessment' requires banks to determine whether a loan has experienced a 'significant increase in credit risk' (SICR) since origination. Which of the following is the best indicator of SICR?
Select an option first.
Correct answer: B — A significant deterioration in the borrower's financial condition, including falling coverage ratios, rising leverage, payment delays, covenant breaches, or negative macro overlay for the borrower's sector.
Explanation: SICR indicators: (1) payment delays (30+ days past due is a rebuttable presumption); (2) covenant breach or waiver request; (3) significant deterioration in financial ratios; (4) watch-listing / internal rating downgrade; (5) adverse macro overlay for the borrower's industry. A is a credit quality level, not change; C and D are not SICR indicators.
Question 398
The concept of 'credit risk transfer' refers to:
Select an option first.
Correct answer: B — The process of moving credit risk from the originating bank to third parties through instruments such as CDS, securitisation, guarantees, or loan sales — enabling capital relief and risk diversification.
Explanation: Credit risk transfer (CRT): banks transfer credit risk to insurance companies (CDS guarantors), capital markets (securitisation), or other banks (loan sales, sub-participations). This provides: (1) regulatory capital relief, (2) economic risk reduction, (3) portfolio diversification, (4) liquidity. A is write-off (realised loss); C is debt assumption; D is a book transfer.
Question 399
A bank originates a portfolio of commercial mortgages and wants to reduce its regulatory capital using securitisation. Under Basel rules, the bank can achieve regulatory capital relief only if:
Select an option first.
Correct answer: B — The securitisation achieves significant risk transfer (SRT) — a meaningful transfer of credit risk to third parties, as evidenced by the economic substance of the transfer and meeting regulatory SRT tests.
Explanation: SRT tests: Basel requires that securitisation genuinely transfers risk to reduce regulatory capital. SRT is achieved when: (1) the bank retains only a limited first-loss piece; (2) risk retained is proportionate to the risk transferred; (3) SRT is not circumvented by contractual features. Retaining 90% (A) would fail SRT. C and D are not SRT tests.
Question 400
Credit risk governance failures that contributed to the 2007-2009 financial crisis included which of the following?
Select an option first.
Correct answer: B — Originate-to-distribute incentive misalignment, inadequate due diligence on complex products (CDOs, ABS), over-reliance on credit ratings, and insufficient independent challenge in the credit process.
Explanation: 2008 crisis governance failures: (1) originate-to-distribute eliminated originator skin-in-game; (2) credit due diligence was insufficient for CDO² and ABS CDO; (3) rating agencies were paid by issuers (conflict of interest); (4) risk management was subordinated to revenue; (5) credit committees rubber-stamped deals under growth pressure. A, C, D are incorrect or reverse the actual failures.
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