LGD Calculator - Loss Given Default | Free Online Finance Tool

What is Loss Given Default (LGD)?

Definition and Importance
Components of LGD
LGD vs Other Risk Metrics

Loss Given Default (LGD) is a critical credit risk metric that measures the percentage of exposure that a lender expects to lose if a borrower defaults on their loan. It represents the portion of the outstanding debt that cannot be recovered through various recovery mechanisms such as collateral liquidation, legal proceedings, or restructuring.

Key Components of LGD

LGD calculation involves several key components: Exposure at Default (EAD), which is the total amount owed at the time of default; Recovery Amount, which is the actual amount recovered; and Recovery Rate, which is the percentage of exposure recovered. The formula is: LGD = (EAD - Recovery Amount) / EAD = 1 - Recovery Rate.

Understanding LGD is essential for banks and financial institutions as it directly impacts capital requirements under Basel III regulations, loan pricing decisions, and overall portfolio risk management strategies.

LGD Calculation Examples

A $100,000 mortgage with $80,000 recovery has LGD = 20%
An unsecured $10,000 loan with $2,000 recovery has LGD = 80%

Step-by-Step Guide to Using the LGD Calculator

Input Requirements
Calculation Process
Interpreting Results

To use the LGD calculator effectively, you need to provide the Exposure at Default (EAD), which is mandatory, and either the Recovery Amount or Recovery Rate. The calculator will automatically compute the LGD percentage and related risk metrics.

Required Inputs

Exposure at Default (EAD) is the total outstanding amount at the time of default, including principal, accrued interest, and fees. Recovery Amount is the actual amount recovered through various means. If you provide a Recovery Rate instead, the calculator will calculate the recovery amount automatically.

Optional Inputs

Collateral Value helps assess the potential recovery value. Time to Recovery and Discount Rate are used to calculate the present value of recoveries, which is important for risk-adjusted return calculations.

Calculation Examples

Enter EAD: $100,000, Recovery: $70,000 → LGD = 30%
Enter EAD: $50,000, Recovery Rate: 40% → LGD = 60%

Real-World Applications of LGD

Banking and Finance
Regulatory Compliance
Portfolio Management

LGD calculations are fundamental to modern banking and financial risk management. They are used in capital adequacy calculations under Basel III, loan pricing models, credit scoring systems, and portfolio risk assessment.

Regulatory Applications

Under Basel III regulations, banks must calculate their capital requirements based on three key parameters: Probability of Default (PD), Exposure at Default (EAD), and Loss Given Default (LGD). Accurate LGD estimates are crucial for regulatory compliance and capital efficiency.

Business Applications

LGD is used in loan pricing to ensure adequate compensation for credit risk, in portfolio management to assess concentration risk, and in stress testing to evaluate potential losses under adverse economic scenarios.

Practical Applications

Basel III capital requirements calculation
Loan pricing and risk-adjusted return analysis

Common Misconceptions and Correct Methods

LGD vs Recovery Rate Confusion
Time Value Considerations
Collateral Valuation Issues

A common misconception is that LGD and Recovery Rate are the same thing. While they are related (LGD = 1 - Recovery Rate), they represent different perspectives on the same risk. LGD focuses on the loss, while Recovery Rate focuses on what can be recovered.

Time Value of Money

Many calculations ignore the time value of money. The present value of recoveries should be considered, especially for long recovery periods. A recovery of $100,000 in 2 years is worth less than $100,000 today.

Collateral Valuation

Collateral values can fluctuate significantly between origination and default. Using original collateral values without considering market conditions can lead to inaccurate LGD estimates.

Common Mistakes

LGD = 30% means 30% loss, not 30% recovery
Future recoveries must be discounted to present value

Mathematical Derivation and Examples

Basic LGD Formula
Advanced Calculations
Risk-Adjusted Metrics

The basic LGD formula is straightforward: LGD = (EAD - Recovery Amount) / EAD. However, more sophisticated calculations consider the time value of money, recovery timing, and various recovery costs.

Present Value LGD

When recovery takes time, the present value of recoveries should be used: PV Recovery = Recovery Amount / (1 + discount rate)^time. This gives a more accurate picture of the economic loss.

Expected Loss Calculation

Expected Loss combines LGD with Probability of Default (PD) and Exposure at Default (EAD): Expected Loss = PD × LGD × EAD. This is the foundation of credit risk modeling and capital allocation.

Mathematical Examples

LGD = ($100,000 - $70,000) / $100,000 = 30%
PV Recovery = $70,000 / (1.05)^2 = $63,492

Residential Mortgage Default

Business Loan Default

Unsecured Personal Loan

Credit Card Default