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The main problem is that these non top 30 schools that do this aggressively and deceptively market themselves as "true P/F schools" when talking to applicants.
The reality is that they still rank their students, which for all intensive purposes is the same has having grades.
IHMO there isn't valid reason for grades during M1/M2. Yes, there is a significant difference between someone who scores 80% on most exams vs. someone who scores 95%. However, due to the variability of grading and curriculum between schools, its not possible to accurately and fairly compare applicants from 2 different schools using preclinical grades (which is the whole point of having grades/rankings for residency applications).
As long as the student passed the course and did well on step 1, that should be enough to assure understanding of the material. At the same time, if your goal is to stratify students, using standardized tests like the steps and shelf exams in addition to home rotation grades, audition rotation grades, and SLORs seems like the best option.
You're assuming the grading during that stage is for giving residency directors info on candidates, what about just ensuring basic competency in the students? I guess you could make the classes harder, but if you do true P/F at the crappy schools, going to have way more people scraping by getting 70 and 71s and a lot less understanding of material
