Loss given default (LGD)

Loss given default (LGD) is the share of a loan or exposure a lender expects to lose if a borrower defaults, after accounting for whatever is recovered through collateral, guarantees, or collections. It is expressed as a percentage of the exposure and is typically calculated as 1 − recovery rate.

LGD is one of the three components, together with probability of default and exposure at default, used to calculate expected credit loss: expected loss = PD × LGD × exposure at default. LGD varies substantially with what secures the loan — a fully collateralized mortgage typically has a much lower LGD than an unsecured personal loan or credit card balance — and with the seniority of the debt in a default or bankruptcy. This distinguishes it from PD, which measures the chance of default happening at all, independent of how much would actually be lost.

Banks estimate LGD from historical recovery data on defaulted loans, and it feeds directly into loan pricing, loss provisioning under IFRS 9 or CECL, and regulatory capital requirements under Basel. Like PD models, LGD models fall under model risk management and must be validated and monitored, since recovery rates shift with collateral values and economic conditions — an LGD estimated in a strong housing market can understate losses once prices fall.