LGD Calculator – Loss Given Default

Loss Given Default represents the proportion of a total credit exposure that is lost when a borrower defaults, expressed either as a percentage or a monetary value. The core calculation relies on two primary metrics: Exposure at Default (EAD) and Loss Severity. First, Loss Severity is calculated as the complement of the Recovery Rate, defined mathematically as Loss Severity = 1 - Recovery Rate. Next, the monetary Loss Given Default is derived by multiplying the total Exposure by the Loss Severity: LGD = Exposure × Loss Severity. This framework allows institutions to isolate how collateral values and liquidation efficiencies directly impact credit risk exposure.

Imagine a commercial bank extends a corporate loan facility with an Exposure at Default (EAD) of $1,200,000. In the unfortunate event of default, the bank estimates it can recover 40% of the asset value through collateral liquidation and legal proceedings, yielding a Recovery Rate of 0.40. First, we compute the Loss Severity by subtracting the recovery rate from one: Loss Severity = 1 - 0.40 = 0.60 (or 60%). Next, we calculate the absolute monetary Loss Given Default by multiplying the exposure by this severity factor: LGD = $1,200,000 × 0.60 = $720,000. This means the bank faces a net economic loss of $720,000 upon default.

Accurate LGD estimation requires conservative assumptions regarding market volatility and collateral liquidation timelines. Always factor in liquidation costs, legal fees, and administrative expenses when estimating your expected recovery rate, as these friction costs directly diminish net recoveries. Furthermore, regularly stress-test your LGD models against severe macroeconomic downturns where collateral values typically plummet simultaneously across various asset classes.