Glossary term
Loss Given Default (LGD)
Loss given default is the share of a loan or credit exposure a lender expects to lose after a borrower defaults, net of recoveries.
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What Is Loss Given Default?
Loss given default, or LGD, is the share of a loan or credit exposure a lender expects to lose after a borrower defaults, net of recoveries. It is usually expressed as a percentage of exposure at default.
LGD is a core credit-risk measure. It helps lenders, bond investors, banks, and risk managers estimate how severe a default could be, not just how likely the default is. A borrower may default, but the final loss depends on collateral, seniority, legal process, recovery value, and costs.
Key Takeaways
- LGD measures expected loss severity after default.
- It is closely related to the recovery rate.
- Collateral, loan seniority, bankruptcy costs, and economic conditions can change LGD.
- LGD is often used with probability of default and exposure at default in credit-risk models.
The Basic Relationship
The simple version is that LGD equals one minus the recovery rate. If a lender recovers 60% of an exposure after default, the LGD is 40%. Real-world estimates can be more complex because recovery may take time and involve legal, servicing, or liquidation costs.
Credit-Risk Input | What It Measures |
|---|---|
Probability of default | How likely the borrower is to default. |
Exposure at default | How much is owed or exposed when default happens. |
Loss given default | How much of the exposure is expected to be lost after recoveries. |
Expected loss | Combines likelihood, exposure, and severity. |
What Drives LGD
A secured loan may have a lower LGD than an unsecured loan if collateral can be sold for meaningful value. Senior debt may recover more than subordinated debt because it has a higher claim priority. Loans backed by specialized assets may have higher LGD if those assets are difficult to sell.
Economic conditions matter too. Collateral values may fall during a downturn, buyers may be scarce, and bankruptcy or foreclosure processes may take longer. That can push realized losses above normal-cycle estimates.
Why Investors Track It
Bond yield, loan pricing, credit spreads, and bank capital planning all depend on loss severity. A low default probability can still produce meaningful risk if LGD would be high. A higher default probability may be more manageable if collateral and seniority support strong recoveries.
LGD can be estimated before default or measured after default. The estimate may use historical recovery data, collateral values, seniority, borrower type, and downturn assumptions. The realized number can differ once legal costs, timing, and market conditions are known.
For consumers, the concept appears indirectly in loan pricing. Lenders may charge different rates or require collateral because they are thinking not only about whether default might happen, but also how much they could recover if it does.
The Bottom Line
Loss given default measures how bad a default may be after recoveries. It is the severity side of credit risk, and it should be considered alongside default probability, exposure size, collateral, and recovery timing.