Loss Given Default - LGD

The amount of funds that is lost by a bank or other financial institution when a borrower defaults on a loan. Academics suggest that there are several methods for calculating the loss given default, but the most frequently used method compares actual total losses to the total potential exposure at the time of default.

Of course, most banks don't simply calculate the LGD for one loan. Instead, they review their entire portfolio and determine LGD based on cumulative losses and exposure.

Institutions such as banks will determine their credit losses through an analysis of the actual loan defaults. While quantifying some losses may be simple, in some situations it may be quite difficult and require the analysis of multiple variables. For example, if Bank X loans $1 million to ABC Company and ABC defaults on the note, Bank X's loss isn't necessarily $1 million. This is because Bank X may hold substantial assets as collateral, and/or may use the courts in an effort to be made whole. When all of these variables are factored in, Bank X may have lost substantially less than the original $1 million loan. The process of analyzing all of these variables (as well as all of the other loans in Bank X's portfolio) is paramount to determining the loss given default.