Regulatory Expected Loss
Contents
Definition
Regulatory Expected Loss (EL) is a metric introduced by the Basel II regulatory standard[1]. It denotes the ratio of the amount expected to be lost on an exposure from a potential default of a counterparty or dilution over a one-year period to the amount outstanding at default.[2]
Calculation of Expected Loss
The financial institution must sum the EL amount (defined as PD multiplied by EAD and LGD) associated with its performing exposures (excluding the EL amount associated with equity exposures under the PD/LGD approach and securitisation exposures) to obtain a total EL amount.
Expected Loss for Defaulted Assets
Recognising the principle that realised losses can at times systematically exceed expected levels, the LGD assigned to a defaulted asset should reflect the possibility that the bank would have to recognise additional, Unexpected Loss during the recovery period. For each defaulted asset, the bank must also construct its best estimate of the expected loss on that asset based on current economic circumstances and facility status. The amount, if any, by which the LGD on a defaulted asset exceeds the bank’s best estimate of expected loss on the asset represents the capital requirement for that asset
Instances where the best estimate of expected loss on a defaulted asset is less than the sum of specific provisions and partial charge-offs on that asset will attract supervisory scrutiny and must be justified
