Guidance on the estimation of loss given default (Reference to Paragraph 468 of the Basel II framework)
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The Committee has determined that a principles-based approach to elaborating on the requirements of paragraph 468 is most appropriate at this time. This approach is intended to ensure that banks have systems in place for identifying downturn conditions and for incorporating these conditions into LGD estimates where appropriate. The principles articulated in this document are designed to be flexible enough to allow for a range of sound practices and to encourage continued work in this area, while also clarifying the Committee's expectations. These principles are not intended to amend the Revised Framework or to introduce any new rules. The Committee will continue to monitor industry practice through the Accord Implementation Group and may provide additional guidance as industry practices evolve. This document is organised into six sections. Section I defines terms used throughout this document. Section II articulates a principle for the quantification of LGD parameters consistent with paragraph 468 of the Framework Document. Section III discusses a principle for discounting recovery cash flows used in LGD estimation. Section IV discusses the possibility that for validation purposes supervisors may request that banks provide supplemental information on the average loss rate given default for some exposures. Section V provides guidance to supervisors concerning the development of fallback solutions that might be permitted on a transitional basis in circumstances where banks cannot satisfy the principle articulated in Section II. Section VI clarifies the relationship between the LGD quantification requirements in paragraph 468 and stress testing requirements discussed in paragraphs 434 and 435 of the Framework Document.