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Credit Losses Formula:
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Credit losses represent the expected financial loss from credit risk, calculated as the product of probability of default (PD), loss given default (LGD), and exposure at default (EAD). This formula is fundamental in credit risk management and financial analysis.
The calculator uses the credit losses formula:
Where:
Explanation: The formula multiplies the probability that a borrower will default by the percentage of exposure that will be lost if default occurs, and by the total exposure amount at the time of default.
Details: Accurate credit loss estimation is crucial for banks and financial institutions to set aside adequate provisions, determine capital requirements, price loans appropriately, and manage overall credit risk exposure.
Tips: Enter PD and LGD as percentages (0-100%), and EAD in currency units. All values must be valid (PD and LGD between 0-100, EAD ≥ 0).
Q1: What Is Probability Of Default (PD)?
A: PD is the likelihood that a borrower will default on their obligations within a specific time period, typically expressed as a percentage.
Q2: What Is Loss Given Default (LGD)?
A: LGD represents the percentage of exposure that will be lost if default occurs, taking into account recovery rates from collateral or other sources.
Q3: What Is Exposure At Default (EAD)?
A: EAD is the total value that a bank is exposed to when a loan defaults, including outstanding principal and accrued interest.
Q4: How Is This Used In Banking?
A: Banks use this calculation for credit risk management, regulatory capital calculation under Basel frameworks, and loan loss provisioning under IFRS 9.
Q5: What Are Typical Ranges For PD And LGD?
A: PD typically ranges from 0.1% to 20% depending on credit quality, while LGD usually ranges from 20% to 60% depending on collateral and recovery prospects.