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Loss given default or LGD is the share of an asset that is lost if a borrower defaults. It is a common parameter in risk models and also a parameter used in the calculation of economic capital, expected loss or regulatory capital under Basel II for a banking institution. This is an attribute of any exposure on bank's client.
Expected Default is a risk calculated for the number of times a default will likely occur from the borrower. Expected Severity refers to the total cost incurred in the event a default occurs. This total loss includes loan principle and interests. Unlike Expected Loss, organizations have to hold capital for Unexpected Losses.
Credit default risk – The risk of loss arising from a debtor being unlikely to pay its loan obligations in full or the debtor is more than 90 days past due on any material credit obligation; default risk may impact all credit-sensitive transactions, including loans, securities and derivatives.
Financial risk modeling is the use of formal mathematical and econometric techniques to measure, monitor and control the market risk, credit risk, and operational risk on a firm's balance sheet, on a bank's accounting ledger of tradeable financial assets, or of a fund manager's portfolio value; see Financial risk management.
Traditional inflation-free rate of interest for risk-free loans: 3-5%; Expected rate of inflation: 5%; The anticipated change in the rate of inflation, if any, over the life of the investment: Usually taken at 0%; The risk of defaulting on a loan: 0-5%; The risk profile of a particular venture: 0-5% and higher
The Merton model, [1] developed by Robert C. Merton in 1974, is a widely used "structural" credit risk model. Analysts and investors utilize the Merton model to understand how capable a company is at meeting financial obligations, servicing its debt, and weighing the general possibility that it will go into credit default.
Based on Basel Guidelines, EAD for commitments measures the amount of the facility that is likely to be drawn further if a default occurs. [3] Two popular terms used to express the percentage of the undrawn commitment that will be drawn and outstanding at default (in case of a default) are Conversion Factor (CF) [4] and Loan Equivalent (LEQ). [5]
Expected loss is not time-invariant, but rather needs to be recalculated when circumstances change. Sometimes both the probability of default and the loss given default can both rise, giving two reasons that the expected loss increases. For example, over a 20-year period only 5% of a certain class of homeowners default.
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