Professional Banker Magazine | An Approach for Estimating Loss Given Default

Professional Banker Magazine:

An Approach for Estimating Loss Given Default

Article Details

Pub. Date	:	October, 2009
Product Name	:	PROFESSIONAL BANKER
Product Type	:	RISK MANAGEMENT
Product Code	:	PBRM10910
Author Name	:	Ajay Sinha
Availability	:	YES
Subject/Domain	:	Finance
Download Format	:	PDF Format
No. of Pages	:	10

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	Abstract
	LGD is dependent on many factors, such as the degree of subordination of debt, collateral and macroeconomic conditions, etc. LGDs are difficult to estimate, if proper structured methodology is not employed.

Description

LGD is derived as 1-Recovery Rate where, Recovery Rate = [Present Value (PV) of {Cash flows received from the borrower post-default - Costs of recovery + Market value of securities received after disposal, if any}]/Outstanding as on date of default.

This concept is further refined to distinguish between the ex-post measures of LGD on defaulted facilities and ex-ante measures on non-defaulted facilities.

LGD for a defaulted facility is the ex-post loss expressed as a percentage of the exposure at the time of default. LGD for a non-defaulted facility is defined as the ex-ante estimate of loss conditional on the default, expressed as a percentage of the Exposure at Default (EAD).

A Reference Data Set (RDS), which includes realized LGD on defaulted facilities, can be used to estimate LGD on non-defaulted facilities. There are different methods that can be used to assign an LGD to non-defaulted facilities. These can be classified into subjective and objective methods according to the type of input used.

Keywords

Professional Banker Magazine, Loss Given Default, LGD, credit obligation, Exposure at Default, EAD, Probability of Default, PD, Reference Data Set, RDS, Cash Flow, Restructuring Cost, Emerging Economies, Macroeconomic Factors, Ordinary Least Square, OLS, Decision-Making Process.