Define the risk of ‘layering’ and how does it affect Loss-given default (LGD)?
Answers
Step-by-step explanation:
KEY TAKEAWAYS
The loss given default (LGD) is an important calculation for financial institutions projecting out their expected losses due to borrowers defaulting on loans.
The expected loss of a given loan is calculated as the LGD multiplied by both the probability of default and the exposure at default.
Exposure at default is the total value of the loan at the time a borrower defaults.
An important figure for any financial institution is the cumulative amount of expected losses on all outstanding loans.
LGD is an essential component of the Basel Model (Basel II), a set of international banking regulations.
Understanding Loss Given Default
Banks and other financial institutions determine credit losses by analyzing actual loan defaults. Quantifying losses can be complex and require an analysis of several variables. An analyst takes these variables into account when reviewing all loans issued by the bank to determine the LGD. How credit losses are accounted for on a company’s financial statements include determining both an allowance for credit losses and an allowance for doubtful accounts.
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