Loss given default (LGD)

Discounted net recoveries and workout LGD

Measure loss from cash-flow shortfalls, recovery costs, and timing after default.

A visual overview of Measure loss from cash-flow shortfalls, recovery costs, and timing after default. See the guide for assumptions and implementation details.

Purpose

Calculate an illustrative workout LGD from exposure and discounted net recovery cash flows.

Key terms

Hover over or focus a term for a quick definition, or open its glossary entry.

Key definitions

Workout LGD compares exposure at default with the present value of recoveries net of relevant costs.
Recovery timing matters because delayed cash flows have lower present value.

Formula

LGD = max(0, (EAD − PV(net recoveries))/EAD), subject to the method's treatment of excess recoveries.

Worked example

EAD $10,000 and PV of net recoveries $6,500 give illustrative LGD 35%.

Detailed explanation

A realized workout view follows the cash flows after default. Include timing, collateral proceeds, guarantor recoveries, legal and collection costs, and other directly attributable costs according to the chosen method. Discounting keeps nominal recovery amount and economic value from being confused.

For a simple educational calculation, divide discounted net loss by EAD and cap or otherwise handle values according to a documented convention. Production accounting and prudential methods may prescribe different details, including effective-interest-rate or downturn considerations. Keep gross recoveries, costs, discount assumptions, unresolved cases, and final workout outcomes visible so a reviewer can reproduce the estimate.

Try a reproducible Python example

These examples use synthetic inputs and run locally in a browser worker. Edit the code, run it, and compare its output with the published example.

Runnable Python · local in your browser

Link re-default episodes and calculate discounted LGD

Apply a declared synthetic 12-month cure probation and compute two episode LGDs from bounded cashflow lists.

Editable Python example

from math import pow

# Synthetic example policy only: a re-default before 12 months links to the open episode.
cure_probation_months = 12
return_to_current_month = 6
redefault_month = 15
probation_complete_month = return_to_current_month + cure_probation_months
episode = 1 if redefault_month < probation_complete_month else 2
print("Month {} re-default linked to Episode {}".format(redefault_month, episode))

def pv(cashflows, annual_rate=0.05):
    return sum(amount / pow(1 + annual_rate, year) for amount, year in cashflows)

episodes = [
    {"name": "Episode 1", "ead": 10000, "recoveries": [(3000, 1), (2500, 2), (1500, 3)], "costs": [(200, 1), (150, 2)]},
    {"name": "Episode 2", "ead": 4000, "recoveries": [(1600, 1)], "costs": [(100, 1)]},
]
for item in episodes:
    pv_recoveries = pv(item["recoveries"])
    pv_costs = pv(item["costs"])
    lgd = (item["ead"] + pv_costs - pv_recoveries) / item["ead"]
    print("{}: PV recoveries={:,.2f} USD; PV costs={:,.2f} USD; illustrative LGD={:.2%}".format(item["name"], pv_recoveries, pv_costs, lgd))

Output

Run the code to see the output.

Runtime loads only after you press Run. Code runs in a separate browser worker with a 10-second limit and a 20,000-character output cap. Use synthetic examples only; browser execution is not a secure environment for secrets or sensitive records.

Runnable Python · local in your browser

Discount recovery cash flows for workout LGD

Discount synthetic recoveries and costs to default date and calculate a capped loss fraction.

Editable Python example

Output

Run the code to see the output.

Assumptions

EAD, recovery cash flows, direct costs, and discount rate refer to one consistent exposure and methodology.

Limitations

The discount rate and cost perimeter depend on the accounting or regulatory methodology.
A single average LGD can hide collateral, product, and recovery-channel differences.

References

Basel Framework: IRB approach and credit-risk components — Basel Committee on Banking Supervision
Guidelines on PD estimation, LGD estimation and treatment of defaulted assets — European Banking Authority
IFRS 9 Financial Instruments — IFRS Foundation

Educational material only. Methods and examples are simplified; state and validate the assumptions required for your use case.