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This value does not take account of guarantees, collateral or security (i.e. ignores Credit Risk Mitigation Techniques with the exception of on-balance sheet netting where the effect of netting is included in Exposure At Default). For on-balance sheet transactions, EAD is identical to the nominal amount of exposure.
It can be mortgages or it can be a custody account or a commodity. The higher the value of the security the lower the LGD and thus the potential loss the bank or insurance faces in the case of a default. Banks using the A-IRB approach have to determine LGD values, whereas banks within the F-IRB do only have to do so for the retail-portfolio ...
For closed-end exposures, EAD must not be lower than the current outstanding balance owed to the bank. For revolving exposures, EAD should take into account any undrawn commitments. For corporate, sovereign or bank exposures, LGD and EAD estimates should be based on a full economic cycle and must not be shorter than a period of seven years.
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In addition to PD models, this framework can also be used to develop PIT and TTC variants of LGD, EAD and Stress Testing models. Most PD models output PDs that are of a hybrid nature: [13] they are neither perfectly Point-In-Time (PIT) nor through-the-cycle (TTC). The long-run average of Observed Default Frequency ODF is often regarded as a TTC PD.
The key variables for (credit) risk assessment are the probability of default (PD), the loss given default (LGD) and the exposure at default (EAD).The credit conversion factor calculates the amount of a free credit line and other off-balance-sheet transactions (with the exception of derivatives) to an EAD amount [2] and is an integral part in the European banking regulation since the Basel II ...