Loss Given Default

Loss Given Default (LGD ) is in credit risk management, the term for the loss rate.

The LGD is in addition to the probability of failure (probability of default, or often abbreviated as "PD ") and the exposure at default ( = outstanding commitments in the event of default ) relevant for the determination of the so-called expected loss (expected loss, or often just as " EL ") of a credit transaction or a loan portfolio. To determine the LGD of the expected loss is set in the event of default in relation to the exposure at default in the ex -ante analysis. The loss must be as defined by Basel II correspond to the "economic loss ". In the ex -post observation is, however, calculated from the realized costs and revenues of the LGD.

The LGD parameter is receiving increasing regulatory attention, as it is centrally especially in real estate financing. The first generation ( 2000s ) LGD models were often in the pool means valid ( the average of the borrower ), but not at the borrower level. This resulted also pricing problems for the corresponding banks. So-called recovery rate estimators are considered best practice for the calculation of LGD parameters for the different segments (Retail, Mortgages, Corporate). The recovery rate estimator determine revenues and losses, for example, for real estate financing of influencing factors such as the economic power of nearby urban areas, infrastructure and accessibility (public transport, connectivity ), the square footage, the standard, the regional recreational value, etc.

Time-dependent revenue and costs are then calculated relative to the EEAS. The (time-dependent ) LGD results. Increasing emphasis is specifically placed on the time dependence of LGD estimates - this is particularly relevant in the light of IFRS 9 ( term-dependent PD and LGD values). With the changing object value in the equipment and real estate financing also LGD and thus the filing agent for the bank to capital changes.

Factors affecting the "economic loss " are:

  • Proceeds from the disposal of collateral
  • Other income ( payments of the borrower, payments from the insolvency rate )
  • Internal and External Costs
  • Temporal structure of costs and revenues ( present value of the time of failure )
  • Opportunity costs (cost of equity tied up )
  • Opportunity revenue ( tax savings )
  • Loss of capital ( depreciation, individual allowances )
  • Present value losses on restructuring of credit exposures

For a bank own or developed in conjunction with other banks LGD method is a prerequisite to achieve the advanced Basel II approach. ( IRB)

  • Risk Management ( Bank)
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