Failure rate

The loss rate or loss rate loss , even in English as Loss Given Default designated (abbreviation LGD) is, in the banking a bank supervisory legal risk parameters for measuring the credit risk .

General

In addition to the loss of default rate or loss rate for short (abbreviation LGD from English loss given default ), there are also risk parameters of default probability (abbreviation PD from English probability of default ) and the default volume (loan amount at the time of default, equivalent to the amount of the claim in the event of default of all risk positions for a debtor ; EaD). These parameters were first introduced in January 2007 in all EU member states , in Germany through the Solvency Regulation . Since January 2014, its supervisory function has been taken over by the Capital Adequacy Regulation (CRR), which is also applicable in all EU member states . It provides legal definitions for these parameters . According to this, the loss rate or loss of default rate - referred to in this ordinance as the “loss default rate” - is “the amount of the loss in risk positions due in the event of default by the counterparty , measured against the amount of risk positions outstanding at the time of default ” (Art. 4 Para. 1 No. 55 CRR). All three are hypothetical quantities based on stochastic probabilities .

scope

According to Art. 5 (2) CRR, “loss” means the economic loss including “significant discounting effects as well as significant direct and indirect costs of collection”. "Economic loss" includes:

• Proceeds from the realization of loan collateral,
• Other income (payments from the borrower , payments from the insolvency quota ),
• Internal and external costs (such as legal advice )
• Opportunity costs (costs for tied-up equity),
• Opportunity revenue (tax savings),
• Loss of capital ( depreciation , individual value adjustments ) or
• Present value losses when restructuring credit exposures.

This loss has not yet occurred at the time the LGD was determined; it is therefore a question of a loss of receivables that lies in the future and therefore has to be forecast . With LGD, neither the amount of loss nor the time of the loan default are known at the time of calculation. According to Art. 178 CRR, default is considered to have been given if it is unlikely that the debtor will settle his liabilities in full or a material liability of the debtor is more than 90 days overdue.

The loss and the recovery rate (RR abbreviated from English recovery rate ) add up to 1, that are complementary:

${\displaystyle {\mbox{LGD}}={{\mbox{1}}-{\mbox{RR}}}}$

The lower the loss rate, the higher the recovery rate. Since the recovery rate, the recycling proceeds of any loan collateral are taken into account, measures the loss ratio, which loan loss is expected to suffer a financial institution after realization of the collateral. In order not to have to accept a loan default, the risk of fluctuations in the value of loan collateral must be eliminated through a careful collateral valuation.

calculation

The loss rate (LGD) is estimated on the basis of historical, comparable loss data for each rating level . The estimate must be based on the same definition of the failure event as the forecast of the probability of failure (PD). Instead of your own loss data, you can also use market data on failed bonds or other marketable loans . The loss is the percentage of the remaining credit at failure for the bank as a loss bad debts at failure volume (EAD). As a formula:

${\displaystyle {\mbox{LGD}}={{\mbox{EL}}/{\mbox{EaD}}}}$

Here referred to

• LGD the loss rate,
• EL is the expected failure height,
• EaD is the default volume.

According to Art. 181 CRR, an economic downturn , a substantial positive correlation between the debtor's credit risk and credit security and a currency mismatch between credit and credit security must be taken into account in the loss rate .

application

Credit institutions that choose the credit risk standardized approach or the IRB basic approach for their rating are given the loss quota by the banking supervisory authority as a standard value - as is the default volume (EaD).

General

In contrast to the probability of default, the loss rate for multiple loans to the same borrower can vary depending on whether they are unsecured or secured. Loans against collateral reduce the LGD value because the credit risk of the lender reduced. Therefore, there is no uniform loss rate for borrowers as soon as several distinguishable loans are granted. In the basic IRB approach, the credit period is specified as a uniform 2.5 years (Art. 162 Para. 1 CRR).

Unsecured loans

Also unsecured loans compared to the same borrower may lead to different loss rates when they have different ranking points. Senior unsecured loans ("senior debt") receive a loss rate of 45% (Art. 161 para. 1a CRR), subordinated blank loans within the scope of mezzanine financing ("junior debt") 75% (Art. 161 para. 1b CRR).

Loan collateral

In the basic IRB approach, loan collateral is taken into account by reducing the loss rate. In the case of recognized financial collateral, the loss rate for the secured part of the loan is reduced to 0%. For the remaining collateral, the loss rate is reduced by up to 35% ( assignment of receivables and real loans ) or 40% (other collateral), whereby an overcollateralization of 125% (assignment of receivables) or 140% of the loan amount (real loans and other collateral) is required. In the case of sureties / guarantees and credit derivatives (as protection buyer ) , the secured loan is assigned the lower risk of the protection seller ( substitution principle , surety substitution ).

Loans in which the ratio of the value (= lending value ) of the collateral to the nominal amount of the loan falls below the threshold of 30% (= reciprocal loan-to-value ratio), the loss rate for unsecured loans or, in the case of non-eligible collateral, is assigned to the amount of 50% because the recovery costs could exceed the recovery proceeds. Loans in which the ratio of the value of the collateral to the nominal amount of the loan is between 30% and 140% are also assigned a loss rate of 50%. Loans where the ratio of the value of the collateral to the nominal amount of the loan exceeds 140%, receive a loss rate of 40%. It applies ${\displaystyle C}$ ${\displaystyle E}$ ${\displaystyle B}$

${\displaystyle {\text{B}}={\frac {\text{C}}{\text{E}}}}$

The higher the lending value of a loan security, the lower the reciprocal loan-to-value ratio and thus the loss rate.

For commercial and residential properties different regulations. Retail real estate is valued at a loss rate of 10% and commercial real estate of 15% (Art. 164 (4) CRR).

meaning

The loss rate as a parameter is receiving increasing regulatory attention, as it is particularly important in real estate financing . So-called recovery rate estimates are considered best practice for calculating the loss rate for the different segments ( standardized private customer business , mortgage loans and corporate finance ). The revenue ratio estimates determine revenues and losses for real estate financing, for example, from influencing factors such as the economic strength of nearby agglomerations, infrastructure and accessibility (local public transport, connections), the number of square meters, the standard, the regional leisure value, etc.

Time-dependent revenues and costs are then set in relation to the loan amount in the event of default (EaD). Increasing emphasis is placed specifically on the time dependency of estimates of the loss of default rate , which is particularly relevant in the light of IFRS 9 (maturity-dependent values ​​for the probability of default and loss rate). With the changing mortgage lending value in movables and real estate financing, the default loss rate also changes and with it the own funds to be deposited by the bank .

Individual evidence

1. ↑ Glossary. Loss Given Default. In: security-finder.ch. Retrieved October 31, 2018 . 
2. ↑ Sören Schramm: The importance of potential influencing factors on the recovery rate of bank loans to small and medium-sized companies - A survey in the banking practice by Jens Grunert and Martin Weber: Analysis and assessment of the article . GRIN Verlag, 2009, ISBN 3-640-28702-9 ( limited preview in Google book search). Here page 3.
3. ^ Til Schuermann, What Do We Know About Loss Given Default? , in: David Shimko, Credit Models and Management, 2004, p. 254.
4. ^ Til Schuermann, What Do We Know About Loss Given Default? , in: David Shimko, Credit Models and Management, 2004, p. 249 ff.
5. ↑ Michael K Ong, Internal Credit Risk Models: Capital Allocation and Performance Measurement , 2000, p. 63.
6. ↑ Jochen Kienbaum, Christoph J. Börner: New ways of financing for medium-sized companies , 2003, p. 125.
7. ^ Deutsche Bundesbank, New Capital Requirements for Credit Institutions , Monthly Report September 2004, p. 84.
8. ↑ Basel Committee on Banking Supervision, The New Basel Capital Accord , January 2001, Paragraphs 209–212, p. 45.