LGD In-Default
Contents
Definition
LGD In-Default denotes an estimated (modelled) Loss Given Default measure that applies to a defaulted yet not fully resolved credit exposure.
Regulatory Requirements (EU)
Loss given default for defaulted exposures as referred to in Article 181(1)(h) of Regulation (EU) No 575/2013.
General Requirements
The direct estimation of LGD in-default should be consistent with the LGD for non-defaulted exposures in order to avoid potential cliff effects. Article 54(2)(c) Following this approach it has been further clarified in the draft GL that for the purpose of estimating ELBE and LGD in-default institutions should use the same estimation methods used for estimating LGD on non-defaulted exposures as they are in fact part of the LGD model.
Approach
Under paragraph 193 of the EBA GL on PD and LGD, LGD in-default can be estimated directly or as the sum of ELBE and an add-on capturing the Unexpected Loss related to the exposures in default that may occur during the recovery period.
In particular, the following should be taken into consideration:
- The use of a constant charge for unexpected losses for all defaulted exposures is not risk sensitive. In the ECB’s understanding, therefore, it does not allow an accurate assessment of risk. Where an institution does use a constant charge, it should justify this. It should demonstrate that the constant charge in question is an adequate estimate of all the components of unexpected loss envisaged in paragraph 193(b) of the EBA GL on PD and LGD during the remaining recovery period, i.e. between the date for which estimates are being applied and the final closure of the recovery process. This analysis should be performed at least for every calibration segment.
- LGD in-default estimates are generally expected to be higher than ELBE estimates and only equal for duly justified individual exposures, which are expected to be very limited.
Documentation
For the purposes of estimating LGD in-default institutions should document separately all of the following:
- the break-down of the LGD in-default into its components: the ELBE and the add-on;
- the break-down of the add-on into all of the following components:
- the downturn conditions component calibrated on the downturn adjustment to the long-run average LGD as specified in paragraph 189;
- the MoC component
- any component covering for potential additional unexpected losses during the recovery period referred to in Article 181 (1)(h) of Regulation (EU) No 575/2013; this component should only be included in exceptional circumstances where the potential additional losses are not sufficiently reflected in the components referred to in points (i) and (ii).
