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Theoretically, LGD is calculated in different ways, but the most popular is 'gross' LGD, where total losses are divided by exposure at default (EAD). Another method is to divide losses by the unsecured portion of a credit line (where security covers a portion of EAD). This is known as 'Blanco' LGD.
Exposure at default or (EAD) is a parameter used in the calculation of economic capital or regulatory capital under Basel II for a banking institution. It can be defined as the gross exposure under a facility upon default of an obligor.
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.
Under A-IRB banks are supposed to use their own quantitative models to estimate PD (probability of default), EAD (exposure at default), LGD (loss given default) and other parameters required for calculating the RWA (risk-weighted asset). Then total required capital is calculated as a fixed percentage of the estimated RWA.
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.
Instead of 5% defaulting, say 10% default, largely due to the fact the LGD has catastrophically risen. To accommodate for that type of situation a much larger expected loss needs to be calculated. This is the subject to considerable research at the national and global levels as it has a large impact on the understanding and mitigation of ...
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 ...
Banks can determine their own estimation for some components of risk measure: the probability of default (PD), exposure at default (EAD) and effective maturity (M). The goal is to define risk weights by determining the cut-off points between and within areas of the expected loss (EL) and the unexpected loss (UL), where the regulatory capital ...