What's the difference between through-the-cycle (TTC) and point-in-time (PIT) PD, and why does it matter for capital?

TTC and PIT PDs estimate the same concept (probability of default) but over fundamentally different economic conditions, leading to very different risk management and capital implications.

Point-in-Time (PIT) PD:

Reflects the current economic environment. PIT PDs are:

• High during recessions
• Low during expansions
• Volatile over the business cycle
• Based on current financial conditions, market indicators, and macro variables

Through-the-Cycle (TTC) PD:

Reflects the average default probability across an entire economic cycle. TTC PDs are:

• Relatively stable over time
• Based on long-term fundamental characteristics
• Higher than PIT during good times, lower than PIT during bad times

Example — Ridgemont National Bank rates Crossfield Industries (BBB):

Notice: PIT is more accurate in both periods, but TTC is more stable.

Why It Matters for Capital:

Basel IRB Framework:

Basel regulations are somewhat ambiguous, but the intent is closer to TTC. Using PIT PDs in the capital formula would create procyclical capital:

• In booms: low PDs -> low capital -> banks lend aggressively
• In recessions: high PDs -> high capital requirements -> banks cut lending -> recession deepens

This procyclicality amplifies the business cycle.

IFRS 9 / CECL Provisioning:

Accounting standards (IFRS 9 and US CECL) require PIT estimates for loan loss provisions. The logic: provisions should reflect current conditions, not historical averages.

Practical Impact:

FRM Key Points:

• Rating agencies like Moody's and S&P use TTC methodology — ratings are stable but slow to react
• Internal bank models can be either, but must be consistent
• Converting between TTC and PIT requires a 'cycle adjustment' factor
• The 2008 crisis exposed the danger of TTC ratings that didn't react fast enough to deteriorating conditions

Explore PD modeling in our FRM Part II Credit Risk module.