Define the risk of ‘layering’ and how does it affect Loss-given default (LGD)?
Answers
Answer:
Credit risk layering occurs when there are other high-risk factors in a loan in addition to a high DTI ratio. These include: Low credit scores. Low down payments. Little or no liquid borrower reserves.
What Is Loss Given Default (LGD)?
Loss given default (LGD) is the amount of money a bank or other financial institution loses when a borrower defaults on a loan, depicted as a percentage of total exposure at the time of default. A financial institution’s total LGD is calculated after a review of all outstanding loans using cumulative losses and exposure
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.
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