The Loss Given Default (LGD) is an important key figure for measuring credit risk.
In contrast to the probability of default (PD), which describes the likelihood of the borrower defaulting, the LGD provides information on the actual loss that would occur if the borrower defaulted.
The LGD depends on various factors such as the type of loan, the borrower's industry and the collateral available. The higher the collateral, the lower the expected loss in the event of default. The LGD can be calculated for individual loans as well as for loan portfolios.
The LGD is an important parameter for determining the minimum capital requirements under Basel II and Basel III. Banks must hold sufficient equity to cover losses in the event of default. The LGD flows as an important parameter into the calculation of the required equity capital.
In practice, LGD is often determined by statistical models based on historical data. A careful determination of the LGD is essential for the assessment of credit risks and the risk management of banks.