Loss given default
share of an asset
Loss given default (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. Exposure is the amount that one may lose in an investment.
The LGD is closely linked to the expected loss, which is defined as the product of the LGD, the probability of default (PD) and the exposure at default (EAD).
Definition
LGD is the share of an asset that is lost when a borrower defaults. The recovery rate is defined as 1 minus the LGD, the share of an asset that is recovered when a borrower defaults.
Loss given default is facility-specific because such losses are generally understood to be influenced by key transaction characteristics such as the presence of collateral and the degree of subordination.
How to calculate LGD
The LGD calculation is easily understood with the help of an example: If the client defaults with an outstanding debt of $100,000 and the bank or insurance is able to sell the security (e.g. a condo) for a net price of $80,000 (including costs related to the repurchase), then the loss amount is $20,000, and the LGD is 20% (= $20,000 / $100,000).
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