lossgivendefault

Loss given default, often abbreviated as LGD, is a crucial metric in credit risk management. It quantifies the proportion of a financial exposure that is expected to be lost if a borrower defaults on their obligations. In simpler terms, it represents the percentage of the outstanding amount that a lender anticipates not recovering following a borrower's failure to repay.

LGD is typically expressed as a percentage of the exposure at default (EAD). For instance, if a bank has a loan of $100,000 outstanding to a company, and it estimates its LGD at 40%, it means the bank expects to lose $40,000 if the company defaults. The remaining $60,000 would be recovered through collateral liquidation, legal proceedings, or other recovery actions.

Several factors influence LGD. The presence and quality of collateral are paramount; secured loans generally have lower LGDs than unsecured ones. The seniority of the debt also plays a role, with senior debt having a higher recovery rate and thus a lower LGD compared to subordinated debt. The economic conditions at the time of default, the costs associated with recovery, and the legal framework governing insolvency proceedings all contribute to the final LGD calculation.

Financial institutions use LGD estimations for various purposes, including regulatory capital calculations (e.g., under Basel Accords), pricing loans, setting provisions for potential losses, and portfolio risk assessment. Accurate LGD modeling is essential for maintaining financial stability and making informed lending decisions.