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Loss given default

Loss given default (LGD) is a fundamental parameter in credit risk assessment, defined as the ratio of the loss on an exposure due to the default of an obligor to the amount outstanding at the time of default.^[1] It represents the economic loss a financial institution incurs after accounting for any recoveries from collateral, guarantees, or other mitigation measures following a borrower's failure to meet obligations.^[2] LGD is typically expressed as a percentage of the exposure at default (EAD) and plays a central role in quantifying potential credit losses across portfolios of loans, bonds, and other debt instruments.^[3] In practice, LGD is calculated as 1 minus the recovery rate, where the recovery rate is the proportion of the outstanding exposure that the lender expects to recover post-default through asset liquidation or restructuring.^[4] For instance, if a lender anticipates recovering 40% of a defaulted loan's value, the LGD would be 60%.^[5] This metric forms one of the three core components—alongside probability of default (PD) and exposure at default (EAD)—in the expected loss formula: EL = PD × LGD × EAD, which banks use to estimate overall credit risk and provision for potential impairments.^[6] Regulatory frameworks, particularly the Basel Accords, mandate the estimation of LGD for capital adequacy purposes, requiring banks to incorporate downturn LGD values that reflect adverse economic conditions to ensure sufficient buffers against systemic risks.^[7] Under the Internal Ratings-Based (IRB) approach of Basel II and III, institutions must develop robust LGD models for corporate, sovereign, and bank exposures, often distinguishing between foundation and advanced methods based on the sophistication of their data and modeling capabilities.^[2] These requirements help align capital holdings with the true risk profile of credit portfolios, promoting financial stability.^[8] Several factors influence LGD estimates, including the quality and type of collateral securing the exposure, the seniority of the debt in the borrower's capital structure, prevailing macroeconomic conditions, and sector-specific recovery patterns.^[9] For example, secured loans with high-value collateral like real estate tend to exhibit lower LGDs compared to unsecured obligations, while economic downturns can amplify losses by depressing recovery values.^[10] Empirical studies highlight that LGDs are not static; they vary cyclically and require ongoing calibration using historical default and recovery data to maintain accuracy in risk models.^[11]

Fundamentals

Definition

Loss given default (LGD) is defined as the proportion of an exposure at default (EAD) that a lender is expected to lose in the event of a borrower default, after accounting for any recoveries from collateral, guarantees, or other sources. It represents the economic loss severity conditional on default occurring and is typically expressed as a percentage of the EAD. LGD is equivalent to one minus the recovery rate, where the recovery rate is the portion of the exposure recovered post-default.^[6]^[5]^[2] The concept of LGD emerged in credit risk modeling during the 1990s, particularly with the development of portfolio credit risk frameworks like CreditMetrics, which incorporated recovery assumptions to estimate losses beyond mere default probabilities. It was formalized as a core parameter in regulatory capital requirements under the Basel II Accord in 2004, serving as a key pillar in the internal ratings-based (IRB) approach for calculating credit risk-weighted assets.^[12] The basic formula for LGD is given by:

\text{LGD} = \frac{\text{Exposure at Default (EAD)} - \text{Recovery}}{\text{Exposure at Default (EAD)}}

Here, EAD is the outstanding amount owed at the time of default, including any undrawn commitments that are drawn down, and Recovery is the net amount recovered through asset liquidation, insurance, or other means, net of costs. This formula captures the net loss relative to the total exposure, emphasizing the role of mitigation factors in reducing severity. LGD complements probability of default (PD) and EAD in the expected loss framework, where expected loss equals PD multiplied by LGD multiplied by EAD.^[6]^[5]^[2] Empirical estimates of LGD vary by loan type and security. For unsecured corporate loans, typical LGD values range from 40% to 60%, reflecting limited recovery options. In contrast, loans secured by real estate often exhibit lower LGDs of around 20% to 40%, due to the realizable value of the underlying collateral.^[13]^[2]

Relationship to Other Credit Risk Parameters

Loss given default (LGD) is one of the three primary parameters in credit risk assessment, alongside probability of default (PD) and exposure at default (EAD), which together determine the expected loss (EL) for a credit exposure. The expected loss is calculated as EL = PD × LGD × EAD, where PD represents the likelihood of a borrower defaulting within a specified period, typically expressed as a percentage between 0% and 100%; LGD denotes the proportion of the exposure that remains unrecovered after a default, also ranging from 0% to 100%; and EAD captures the total value at risk at the time of default, measured in absolute monetary terms such as the sum of drawn balances and potential draws on undrawn commitments.^[2]^[14] This multiplicative formula underscores the interdependent contributions of each parameter: PD sets the frequency of potential losses, LGD scales the severity of each loss event, and EAD quantifies the magnitude, enabling banks to estimate aggregate credit risk across portfolios.^[2] LGD exhibits notable interdependencies with PD and EAD, influencing the overall risk profile. Empirical evidence indicates a positive correlation between PD and LGD, where higher PD levels—often associated with riskier borrowers—tend to coincide with elevated LGD due to factors like weaker collateral quality or reduced recovery prospects in distressed scenarios.^[15]^[16] Similarly, LGD interacts with EAD through the treatment of drawn and undrawn commitments; for facilities with undrawn portions, EAD incorporates credit conversion factors to estimate potential drawdowns at default, while LGD may adjust downward if undrawn lines are less likely to be fully utilized or if they affect recovery assumptions, though fully drawn exposures typically yield higher effective LGD.^[2]^[17] These relationships highlight how LGD does not operate in isolation but amplifies or mitigates EL based on the joint behavior of PD and EAD. The workout process following default further intertwines LGD with PD and EAD, as resolution outcomes directly shape recovery rates and thus LGD, while PD influences the timing and EAD the scale of involvement. Key stages include initial assessment and negotiation for a cure, where borrowers may restructure payments to avoid further deterioration, often resulting in minimal or zero LGD if successful; collateral liquidation, involving the sale of secured assets to recoup value, which reduces LGD for collateralized exposures but depends on market conditions and EAD size; and bankruptcy proceedings, where claims are prioritized in asset distribution, typically leading to higher LGD for junior or unsecured portions amid prolonged resolution.^[18] These stages collectively determine the final LGD, with earlier cures (linked to lower PD profiles) preserving more value relative to EAD compared to bankruptcy scenarios.^[18] In practice, the multiplicative nature of the EL formula amplifies the impact of these parameters' ranges: PD often spans 0% to several percent for investment-grade assets but up to 100% in high-risk cases, LGD varies from near 0% for fully secured loans to 100% for unsecured ones, and EAD reflects actual exposures that can range from thousands to billions depending on the portfolio.^[19] For instance, a modest PD of 2%, LGD of 40%, and EAD of $1 million yields an EL of $80,000, but correlations like rising LGD with higher PD can exponentially increase losses in stressed conditions.^[2]^[20] This framework supports comprehensive credit risk management by integrating LGD's role within the broader PD-EAD dynamics.

Calculation Methods

Foundation Internal Ratings-Based Approach

The Foundation Internal Ratings-Based (F-IRB) approach, part of the Basel II and subsequent frameworks, allows banks to develop internal models for estimating probability of default (PD) while relying on supervisory parameters for loss given default (LGD) and exposure at default (EAD) in non-retail portfolios. This method promotes consistency and conservatism by standardizing LGD estimates to limit variability across institutions. For senior unsecured exposures, the supervisory LGD is fixed at 40% for corporates and 45% for sovereigns and banks, reflecting empirical averages of recovery rates observed in default scenarios without mitigation.^[2]^[21] LGD calculation under F-IRB begins with this base value and incorporates adjustments solely for recognized credit risk mitigation, particularly collateral, using a standardized methodology aligned with the comprehensive approach for financial collateral or simple approach for other forms. Without eligible collateral, LGD remains at the applicable base value. With collateral, the adjusted LGD (LGD*) is computed as a weighted average: LGD* = LGD_U × (E_U / E*) + LGD_S × (E_S / E*), where LGD_U is the unsecured LGD (40% for corporates or 45% for sovereigns and banks), E* is the exposure adjusted for bank volatility (E × (1 + H_E)), E_U is the unsecured portion, E_S is the collateral value after haircuts (C × (1 - H_C - H_fx)), LGD_S is 0% for eligible financial collateral and 10% for non-financial collateral (eligible receivables, real estate, or other physical collateral), and H terms represent supervisory haircuts for volatility and currency mismatch.^[2]^[22]^[23] Eligible collateral under F-IRB mirrors the standardized approach criteria, limited to financial instruments (e.g., cash, sovereign debt, equities with specified haircuts of 0-15% for cash and low-risk securities) and non-financial collateral such as receivables, commercial or residential real estate, and other physical collateral (haircut 50%). Recognition requires legal certainty of enforceability, daily mark-to-market for financial collateral, and minimum holding periods; ineligible or illiquid physical collateral like art is excluded. For corporates, sovereigns, and banks, this adjustment caps the effective LGD reduction, ensuring a minimum recovery floor. Banks cannot develop proprietary LGD models for these exposures, distinguishing F-IRB from the advanced IRB approach, which permits internal LGD estimation for greater flexibility.^[2]^[22]^[24] This approach applies exclusively to corporate, sovereign, and bank exposures, excluding retail portfolios where separate treatments prevail, and emphasizes supervisory oversight to maintain capital adequacy without institution-specific modeling of recoveries.^[2]^[21]

Advanced Internal Ratings-Based Approach

Under the Advanced Internal Ratings-Based (AIRB) approach of the Basel II framework, banks are permitted to develop and validate their own models for estimating loss given default (LGD), using historical loss data to derive parameters that reflect long-run average economic losses on defaulted exposures. These models must obtain supervisory approval and apply to all IRB-eligible portfolios, including corporate, sovereign, bank, and retail exposures, allowing for greater customization compared to the Foundation IRB approach's fixed LGD parameters.^[2] The estimation process emphasizes robust, data-driven methodologies to ensure estimates capture the economic reality of recoveries and costs over the workout period following default. Under Basel III final reforms (as of 2025), A-IRB LGD estimates are subject to input floors, such as 25% for senior unsecured non-financial corporate exposures, to constrain variability.^[25] The core estimation process relies on workout recovery data from defaulted facilities, incorporating cash inflows from recoveries net of associated costs, discounted to the point of default to compute the long-run average LGD across economic cycles.^[26] Banks must use a minimum of seven years of data for corporate, sovereign, and bank exposures—or five years for retail exposures—to ensure coverage of economic cycle volatility, with data quality prioritized to reflect the bank's underwriting standards and exposure characteristics.^[27] Where internal data is limited, external or pooled data may supplement estimates, provided there is a strong conceptual link to the bank's portfolio, and supervisory practices often require sufficient observations, such as at least 20 defaults per rating grade or collateral type, to achieve statistical robustness.^[28] LGD estimates must differentiate meaningfully across exposure types and facility grades using intuitive criteria, with downturn conditions integrated to reflect higher losses during periods of economic stress. LGD is fundamentally a function of exposure at default (EAD), recovery amounts, and both direct and indirect costs, expressed as a percentage of EAD to represent the economic loss rate.^[2] Direct costs include workout expenses like legal fees, while indirect costs encompass funding and administrative overheads incurred during the recovery process; recoveries are discounted using an appropriate rate that accounts for the time value of money and holding costs of defaulted assets.^[29] This structure ensures LGD captures the full economic impact, with banks required to document methodologies that avoid over-reliance on collateral valuations alone.^[8] Validation of LGD models involves rigorous internal and external processes, including annual back-testing against realized losses to assess accuracy and consistency over time.^[27] Banks must compare model outputs to observed outcomes using long historical datasets spanning various economic conditions, incorporating quantitative metrics and qualitative reviews to identify biases.^[26] If data limitations or estimation uncertainties arise, a margin of conservatism—such as add-ons or floors—is applied to the LGD estimates to ensure they remain prudent, with supervisors evaluating overall model performance for approval.^[27]

Adjustments and Variations

Downturn Loss Given Default

Downturn Loss Given Default (DLGD) refers to the loss given default parameter calibrated to reflect elevated loss severities during adverse economic conditions, as required under the Basel II framework for banks using internal ratings-based (IRB) approaches to account for the cyclical dependencies between defaults and losses. This adjustment ensures that capital requirements incorporate the heightened risks observed in recessions, where recoveries typically decline due to correlated deteriorations in asset values and market liquidity.^[9] The regulatory requirement for DLGD stems from paragraph 468 of the Basel II document (2004), which mandates that advanced IRB banks estimate LGD values reflecting downturn conditions where necessary to capture relevant risks, with estimates not falling below long-run default-weighted averages. Post-2008 financial crisis, this provision was reinforced in Basel II.5 (2011) to mitigate procyclicality in capital requirements, as the crisis revealed how economic stress amplified losses beyond historical norms, prompting stronger supervisory guidance on incorporating macroeconomic sensitivities. Under Basel III (finalized 2017, with implementation phased from 2023 to 2028), DLGD requirements persist with enhancements for conservatism, such as output floors on risk-weighted assets, to address variability in IRB models while limiting the scope of advanced IRB usage.^[25]^[30] Under the foundation IRB approach, DLGD is addressed through implicit conservatism, such as fixed LGD floors (e.g., 45% for senior unsecured corporate exposures), whereas advanced IRB demands explicit estimation by banks.^[31] DLGD is commonly calculated by adding a downturn adjustment to the long-run LGD, where the adjustment is derived from econometric models regressing observed LGDs on macroeconomic variables, such as GDP growth, unemployment rates, and asset price indices, to quantify the impact of stress scenarios.^[32] For instance, in the extrapolation approach, a model of the form Y_t = \alpha + \sum \beta_j e_{t-l_j} + [\epsilon](/page/Epsilon) is fitted, where Y_t is LGD at time t, e_{t-l_j} are lagged economic factors, and downturn LGD is projected at stressed input levels with confidence intervals for conservatism.^[32] Banks must segment portfolios by factors like exposure type and geography, identify historical downturn periods (e.g., via co-movements in defaults and macro indicators), and validate estimates against observed data, often pooling resources across institutions to overcome data scarcity.^[33] Implementation challenges include defining downturn scopes and handling lagged effects on recoveries, as seen in the 2008 crisis where LGDs spiked significantly due to delayed workout processes and asset devaluations, with losses peaking beyond immediate GDP troughs into 2012 in some cases. Recent supervisory insights, such as from the ECB in 2025, emphasize that credit losses often lag economic signals, further complicating accurate DLGD calibration and underscoring the need for forward-looking model adjustments.^[33]^[34] Empirical evidence from the crisis, drawn from global credit data, showed pronounced LGD increases for secured exposures tied to falling stock returns and rising unemployment, underscoring the correlation with broader economic stress.^[9] Regulatory bodies, such as the Bank of England, require firms to apply the highest average downturn LGD across segments and document methodologies for supervisory review, ensuring DLGD contributes to robust capital buffers against future downturns.^[32]

Corrections for Default Definitions

Different default definitions across regulatory frameworks, accounting standards, or jurisdictions can lead to inconsistent loss given default (LGD) estimates by identifying varying sets of defaulted exposures. For instance, a 90 days past due criterion, as specified in the Basel framework under Article 178 of the Capital Requirements Regulation (CRR), may capture more early-stage defaults compared to stricter regulatory insolvency thresholds used in some contexts. These discrepancies result in biased LGD observations, as exposures defaulting under one definition may exhibit different recovery profiles than those under another. To address this, methodological corrections are applied to harmonize LGD estimates to a uniform standard, ensuring they reflect the underlying risk rather than definitional variations. Adjustment techniques typically involve a mapping exercise to re-estimate LGD under consistent default criteria, often using survival analysis or Cox proportional hazard models to account for timing differences in default identification. A proportional correction factor based on the relative change in default rates is calculated and applied retrospectively to observed data; for example, the adjusted LGD can be derived as the observed LGD scaled by the ratio of the standard default rate to the observed default rate. This approach aligns historical or jurisdiction-specific data with the target definition, such as the Basel 90-day threshold, while incorporating a margin of conservatism (e.g., a 90% confidence interval) to mitigate residual uncertainties. Institutions must document these adjustments, including analyses of biases from short-term contracts or terminated exposures, to ensure representativeness. A practical example arises in retail portfolios when correcting LGD estimates from IFRS 9, which emphasizes impairment recognition and may use a more flexible default definition aligned with internal credit risk management, to the stricter, capital-focused Basel IRB approach. Under IFRS 9, defaults might be identified earlier based on significant increase in credit risk, leading to potentially higher observed LGDs due to incomplete recovery data at the point of impairment; adjustments map these to Basel's unlikeliness-to-pay or 90-day past due criteria, often requiring overlays or recalibration to maintain consistency. Such corrections ensure that LGD parameters used for expected credit loss calculations under IFRS 9 are comparable to those for regulatory capital under Basel.^[35] These corrections are essential for benchmarking LGD estimates across banks and borders, promoting regulatory consistency and reducing non-risk-based variability in internal ratings-based models. By aligning to a common default standard, institutions enhance the reliability of LGD inputs for capital adequacy calculations and facilitate supervisory comparisons, ultimately supporting more accurate risk quantification under the IRB approach. As of July 2025, the European Banking Authority (EBA) launched a consultation on amended Guidelines on the application of the definition of default under Article 178 of the CRR, proposing updates to aspects such as probation periods and days past due thresholds for specific exposures like factoring arrangements, to further improve harmonization and address evolving CRR3 requirements.^[36]

Specialized and Contextual Factors

Country-Specific Loss Given Default

Loss given default (LGD) estimates are significantly influenced by jurisdictional differences in legal frameworks, market conditions, and recovery processes, which can lead to substantial variations in realized recovery rates across countries. In creditor-friendly jurisdictions like the United States, bankruptcy laws such as Chapter 11 facilitate reorganization and asset preservation, often resulting in higher recovery rates for senior creditors compared to emerging markets where weaker rule of law and political risks can diminish recoveries. For instance, S&P Global Ratings classifies U.S. insolvency regimes in Group A, indicating strong creditor protections with no cap on recovery ratings, whereas many emerging market jurisdictions fall into Group C, where unpredictability limits recovery assessments and increases LGD. Regional data from Moody's Analytics further illustrates this, showing average ultimate recovery rates for project finance loans at 83.8% in the European Economic Area (EEA) versus 77.8%-80.0% in emerging market and developing economies (EMDEs), translating to LGDs that are notably higher in the latter due to factors like country risk as a primary default driver.^[37]^[38] Banks calibrate LGD models to these country-specific factors by incorporating local historical data and applying adjustments such as multiplicative overlays to global base models, ensuring estimates reflect jurisdiction-specific recovery dynamics. Under the European Banking Authority's (EBA) guidelines for internal ratings-based (IRB) approaches, institutions must use their own internal loss and recovery data from the relevant jurisdiction, covering a broad historical period to capture varying economic conditions, while accounting for legal environments in collateral realization and recovery costs. These calibrations often involve margins of conservatism to address data deficiencies or legal changes, with downturn LGDs adjusted based on historical scenarios tailored to local insolvency laws. The advanced IRB framework enables such localized modeling by allowing banks to derive facility-specific LGDs informed by country overlays derived from empirical recovery experience.^[39]^[39] Illustrative examples highlight these impacts, particularly in real estate exposures. In the U.S., non-judicial foreclosure processes typically allow lenders to repossess and sell properties relatively quickly, minimizing holding costs and supporting higher recovery rates for secured mortgages, whereas Spain's judicial foreclosure system often involves longer timelines due to court backlogs and borrower protections, contributing to lower recoveries and higher LGDs. In emerging economies, sovereign risk spillovers exacerbate LGDs; for example, country risk accounts for over 35% of defaults in EMDE-A regions (e.g., Mexico, Poland), leading to recoveries 5-10 percentage points below advanced economy averages as government interventions or currency controls hinder asset liquidation.^[40]^[38] Reliable data for these calibrations comes from specialized default databases and regulatory submissions, including Moody's Ultimate Recovery Database, which provides jurisdiction-delineated recovery statistics for corporate and project finance defaults, and national central bank reports such as those from the European Central Bank on loan enforcement frameworks across member states. For IRB approvals, banks submit analyses based on local default databases, often pooled through consortia like Global Credit Data, to benchmark country-specific LGDs while maintaining data anonymity. These sources prioritize empirical observations over market-implied estimates to ensure conservative and verifiable inputs.^[41]^[42]

Retail and Collateralized Exposures

In the advanced internal ratings-based (IRB) approach, which is the only IRB method applicable to retail exposures, banks must estimate loss given default (LGD) using their own internal models based on historical loss data from relevant retail portfolios.^[43] These models incorporate factors such as exposure type, borrower characteristics, and recovery processes, with a minimum data observation period of five years to ensure robustness, though shorter periods require more conservative estimates.^[27] For qualifying revolving retail exposures, such as credit cards and overdrafts up to €100,000 per individual managed on a pooled basis, LGD estimates reflect the unsecured nature and low recovery rates, often resulting in higher values due to limited collateral.^[43] Under Basel III, LGD floors apply to certain retail exposures (e.g., 25% for qualifying revolving retail), influencing model outputs.^[43] Collateralized retail exposures, particularly residential mortgages and auto loans, require LGD models that adjust for the value and realizability of security. Under the advanced IRB approach, banks estimate LGD for secured exposures by incorporating the adjusted collateral value, accounting for market value, haircuts for liquidation costs, and volatility.^[44] For residential mortgages, haircuts are applied based on loan-to-value (LTV) ratios; for example, exposures with LTV below 80% may see substantial LGD reductions, often 70% or more compared to unsecured baselines (which can exceed 80%), reflecting higher recovery from property sales after accounting for enforcement costs and market downturns.^[45] This treatment emphasizes legal enforceability and independent valuations to ensure conservative estimates.^[44] Representative examples illustrate the impact of collateral on retail LGD. Unsecured credit card exposures often exhibit high LGDs around 80%, driven by minimal recoveries from collections and charge-offs, as observed in supervisory stress testing models using historical downturn data.^[46] In contrast, collateralized auto loans typically show lower LGDs of approximately 40%, benefiting from repossession and vehicle resale, though this varies with LTV and economic conditions affecting used car prices.^[47] Estimating LGD for retail exposures presents challenges due to thin data, particularly in low-default portfolios where default events are infrequent, limiting statistical reliability.^[48] To address this, banks often pool data across similar products or with external sources to build sufficient datasets, ensuring the pools are representative of the exposure's risk profile while maintaining data relevance and quality.^[48] This pooling approach is especially critical for smaller retail segments, helping to derive robust long-run average LGD estimates without undue conservatism.^[27]

Importance and Applications

Role in Regulatory Capital Frameworks

Loss given default (LGD) plays a central role in regulatory capital frameworks by serving as a key input parameter in the calculation of risk-weighted assets (RWA) under the Internal Ratings-Based (IRB) approach of the Basel Accords. In the Basel II framework, introduced in 2004 and effective from 2008, banks using the advanced IRB approach estimate their own LGD values alongside probability of default (PD), exposure at default (EAD), and effective maturity (M) to compute the capital requirement factor K through the risk-weight function. This function integrates LGD to reflect the expected severity of losses in the event of default, with RWAs calculated as RWA = EAD × K(PD, LGD, M), and the minimum capital requirement set at 8% of these RWAs.^[31]^[49] The Basel III reforms, finalized in 2010 and phased in starting 2013, enhanced LGD's regulatory treatment to address shortcomings exposed by the 2008 financial crisis, mandating downturn LGD (DLGD) estimates that incorporate economic stress conditions for certain exposures to better capture cyclical risks. Additionally, Basel III introduced input floors for LGD parameters under the advanced IRB approach, such as a 25% floor for unsecured corporate exposures, to prevent excessive capital relief from optimistic internal models. These measures aimed to strengthen bank resilience by ensuring more conservative LGD assumptions in capital calculations.^[25]^[2] Building on Basel III, the Basel IV reforms—finalized in 2017 and with implementation phased from 2023 to 2025—further refined LGD's integration by imposing stricter constraints, including revised LGD floors (e.g., 25% for senior unsecured corporate exposures under the advanced IRB) and an overall output floor limiting RWAs from internal models to no less than 72.5% of those calculated under the standardized approach. As of November 2025, Basel IV implementation varies by jurisdiction: in the European Union, core elements including the output floor began applying from January 2025 with a gradual phase-in to full effect by 2030, while in the United States, finalization of the rules remains ongoing, with earlier proposals indicating a potential transition starting in July 2025 and completion by 2028, though delays are anticipated; this has heightened focus on non-performing loans through enhanced provisioning and stress testing tied to LGD estimates. These updates promote greater consistency and comparability in capital adequacy across banks globally.^[25]^[50]^[51]^[52] Beyond the Basel framework, LGD is integral to other regulatory standards like IFRS 9, effective from 2018, which requires forward-looking LGD estimates in the calculation of expected credit losses (ECL) for provisioning, contrasting with the more through-the-cycle orientation in Basel capital rules. Under IFRS 9, ECL incorporates unbiased, probability-weighted LGD projections adjusted for macroeconomic scenarios, ensuring timely recognition of potential losses on financial instruments. This dual regulatory use of LGD—conservative for capital and prospective for provisions—bridges solvency and accounting requirements while addressing post-crisis emphasis on proactive risk management.^[53]

Use in Credit Risk Management and Modeling

In credit risk management, loss given default (LGD) plays a pivotal role in portfolio stress testing, where institutions simulate adverse economic scenarios to assess the sensitivity of expected losses to changes in recovery rates. For instance, banks evaluate how downturns in collateral values or recovery processes could elevate LGD, thereby increasing overall portfolio vulnerability, as demonstrated in analyses of mortgage loan portfolios where stressed recovery rates led to notable LGD increases under severe housing market declines.^[54] This approach helps identify concentration risks in sectors like real estate or corporate lending, enabling proactive adjustments such as diversification or capital buffers. Additionally, LGD informs loan pricing by incorporating expected loss margins into interest rates; for example, a loan with a 5% probability of default and 40% expected LGD might require a pricing spread that covers the 2% anticipated loss, ensuring profitability while aligning rates with risk exposure.^[55] Advancements in LGD modeling have increasingly incorporated machine learning techniques, such as random forests, to predict recoveries more accurately since the 2010s, particularly for heterogeneous datasets where traditional regressions falter due to non-linear relationships between covariates like collateral type and economic indicators. Random forest models, for instance, have shown improved predictive performance over logistic regressions in cross-sectional studies.^[56] Bayesian methods further enhance modeling for scenarios with scarce default data, generating posterior distributions of LGD that incorporate prior expert knowledge and uncertainty, as applied in unsecured retail loan portfolios to produce individualized predictive densities rather than point estimates.^[57] These techniques integrate seamlessly with IFRS 9 expected credit loss (ECL) staging, where LGD estimates adjust dynamically across stages—using 12-month horizons for Stage 1 and lifetime for Stages 2-3—to inform forward-looking provisions that reflect deteriorating credit quality.^[58] LGD assumptions underpin risk mitigation strategies, including hedging through credit derivatives like credit default swaps (CDS), whose pricing embeds LGD to determine protection payouts upon default events, allowing banks to transfer severity risk while retaining exposure to probability of default. For example, CDS spreads reflect the product of default probability and LGD, enabling institutions to hedge against high-loss scenarios in concentrated portfolios, as evidenced in term structure models that jointly estimate LGD from market-implied data.^[59] LGD is also central to calculating allowances for loan losses under frameworks like IFRS 9, where it forms a component of ECL computations to provision for potential recoveries, ensuring balance sheets reflect economic realities without over- or under-stating impairments.^[53] Post-2020 empirical research highlights LGD volatility in retail sectors amid the COVID-19 pandemic, with studies showing elevated losses in unsecured consumer loans due to disrupted recovery processes and collateral devaluations, where cure rates—the probability of avoiding full loss—declined in affected portfolios. Analyses of retail ECL models during the crisis revealed that LGD sensitivity to macroeconomic shocks, such as unemployment spikes, amplified provisions in non-essential retail lending segments, underscoring the need for scenario-based adjustments in ongoing risk management.^[60]

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QIS 3 FAQ: I. IRB-inputs: PD, LGD and EAD
In order to reflect their own estimates of EAD for undrawn commitments-including commitments that would receive a 0% Credit Conversion Factor under Foundation ...
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Chapter 5 – Credit Risk – Internal Ratings-Based Approach
LGDU floor and LGDS floor are the floor values for fully unsecured and fully secured exposures respectively, as specified in the table in paragraph 98. The ...<|control11|><|separator|>
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[PDF] Implementation of the Basel 3.1 standards: Credit risk mitigation
Nov 30, 2022 · LGDU is the FIRB unsecured LGD applicable to the exposures;. LGDS is the foundation collateral method secured LGD applicable to the collateral.
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Chapter 5 – Credit risk mitigation - Bank of England
Nov 30, 2022 · This chapter sets out the Prudential Regulation Authority's (PRA) proposals to implement the Basel 3.1 standards for credit risk mitigation (CRM).
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[PDF] Guidance on Paragraph 468 of the Framework Document - July 2005
For the estimation of LGDs, measures of recovery rates should reflect the costs2 of holding defaulted assets over the workout period, including an appropriate ...
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[PDF] The Internal Ratings-Based Approach
standardised or foundation IRB approaches. The Committee feels that its ... In setting out a conceptual framework for LGD in the foundation approach, the.<|control11|><|separator|>
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CRE36 - IRB approach: minimum requirements to use IRB approach
Dec 8, 2022 · CRE36 sets minimum requirements for banks using the IRB approach, including 11 sections, focusing on consistent, reliable, and valid risk ...Missing: pillar | Show results with:pillar
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Chapter 4 – Credit risk – internal ratings based approach
Nov 30, 2022 · This chapter sets out the Prudential Regulation Authority's (PRA) proposals to implement the Basel 3.1 standards for the internal ratings based (IRB) approach ...
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[PDF] Financial Stability and Basel II - FDIC
Basel II guidelines include a discussion of the methods and data requirements that are acceptable for estimating the inputs for the IRB capital rules (maturity, ...
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[PDF] An Explanatory Note on the Basel II IRB Risk Weight Functions
All institutions using the IRB approach will be allowed to determine the borrowers' probabilities of default while those using the advanced IRB approach will ...
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[PDF] Guidelines for the estimation of LGD appropriate for an economic ...
The requirement for loss given default (LGD) and conversion factor (CF) estimates to reflect economic downturn conditions was introduced in the Basel II capital ...
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### Summary of Downturn LGDs from AFME Discussion Paper (February 2015)
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https://www.afme.eu/media/yk5hwhs3/afmeprddiscussionpaperondownturnlgds.pdf
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Recovery: Methodology: Jurisdiction Ranking Assessments
Jan 20, 2016 · The criteria establish how we determine a jurisdiction ranking assessment, which is an indicator of the relative degree of protection that a ...Missing: variations | Show results with:variations
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Summary of each segment:
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Below is a merged summary of the guidelines on country-specific calibration of Loss Given Default (LGD), use of local data, and adjustments for jurisdictional differences in recovery. To retain all information in a dense and comprehensive format, I’ve organized the details into tables for each key area, followed by a narrative summary where necessary. The tables are presented in CSV-like format for clarity and completeness, capturing all specifics from the provided segments.
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[PDF] Mortgage Markets and Foreclosure Processes in Europe and the ...
Home mortgage defaults and foreclosures in Europe increased during the crisis, but remain well below those in the United States during the peak years of its.
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Spain's Foreclosure and Bankruptcy Landscape: Stability on the ...
Jul 14, 2025 · -- Courts face structural delays in foreclosure cases, which may be exacerbated if default volumes accelerate. -- Labour market resilience and ...
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[PDF] Corporate Default and Recovery Rates, 1920-2006 - Moody's
Feb 9, 2007 · Investors lost just 23 basis points due to defaults on corporate bonds in 2006, down from 29 bps in 2005 and its low- est annual level on record ...
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[PDF] LGD Report 2019 – Large Corporate Borrowers Appendix
The items are collected on country level and returned on country level unless there are less than three banks providing data in a certain country. In this ...
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Basel Framework
### Summary: LGD Treatment for Retail Exposures under IRB Approach
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Summary of each segment:
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[PDF] Loss Given Default of High Loan-to-Value Residential Mortgages
Aug 4, 2007 · After considering the private mortgage insurance payment calculated as above, the sample average LGD becomes 1.73 percent. ... Journal of the ...Missing: secured | Show results with:secured<|control11|><|separator|>
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The Fed - Descriptions of Supervisory Models
The LGD model assumes that LGD for credit cards is a fixed percentage of EAD. ... FVO/HFS retail loans include first- and second-lien mortgages, student loans, ...
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Descriptions of Supervisory Models - Federal Reserve Board
The LGD model uses projected values of a national used car price index in addition to unemployment rates and house prices that are projected on the state level.
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[PDF] Validation of low-default portfolios in the Basel II Framework
Consequently, relative scarcity of historical loss data in some circumstances may not be a serious impediment to developing PD, LGD and EAD estimates. Where, ...
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CRE31 - IRB approach: risk weight functions
Mar 27, 2020 · This chapter presents the calculation of risk weighted assets under the internal ratings-based (IRB) approach for: (i) corporate, sovereign and bank exposures; ...
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[PDF] Basel III: Finalising post-crisis reforms
A bank must estimate an LGD for each facility that aims to reflect economic downturn conditions where necessary to capture the relevant risks. This LGD ...
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Past & future changes to the Basel Framework
Updated to incorporate the FAQs published on 10 June 2025. Published: 10 Jun 2025Effective as of: 01 Jan 2028Status: Forthcoming. CRE20Standardised approach ...
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https://www.bis.org/basel_framework/timeline.htm
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[PDF] IFRS 9 and expected loss provisioning - Executive Summary
This Executive Summary provides an overview of the ECL framework under. IFRS 9 and its impact on the regulatory treatment of accounting provisions in the Basel ...
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[PDF] Stress Testing the Credit Risk of Mortgage Loans
Nov 14, 2013 · Abstract: In this paper, we analyze the impact of stressed recovery rates for collateral on the average loss given default (LGD) in portfolios ...
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[PDF] Loss Given Default and Economic Capital
For example, if a loan has probability of default equal to 5% and expected LGD equal to 40%, its expected loss is 2%.
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Machine learning loss given default for corporate debt - ScienceDirect
We apply multiple machine learning (ML) methods to model loss given default (LGD) for corporate debt using a common dataset that is cross-sectional.
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[PDF] Modelling LGD using Bayesian methods - Credit Research Centre
Loss borne by a bank when a customer defaults on a loan. • Often used in the form of LGD rate = 1 – Recovery Rate (RR). • LGD estimates:.
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[PDF] Modeling Loss Given Default for CCAR, IFRS 9 and CECL for Retail ...
Loss Given Default or LGD is a key parameter in the expected loss framework for stress testing and allowance calculation for banks.
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[PDF] Estimating Loss Given Default from CDS under Weak Identification
May 8, 2017 · This paper combines a term structure model of credit default swaps (CDS) with weak-identification robust methods to jointly estimate the ...
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The Impact of Covid-19 on Expected Credit Loss of Retail Portfolios
The Cure Rate component of the Loss Given Default (LGD) estimates is where the main interest needs to be placed, as is more sensitive to economic conditions ...