Calculation of Default Risk Capital Requirement

Where a bank has approved loss-given-default (LGD) 52 estimates as part of the IRB approach, this data must be used. Where such estimates do not exist, or SAMA determines that they are not sufficiently robust, LGDs must be computed using a methodology consistent with the IRB methodology and satisfy the following conditions. (1) LGDs must be determined from a market perspective, based on a position’s current market value less the position’s expected market value subsequent to default. The LGD should reflect the type and seniority of the position and cannot be less than zero. (2) LGDs must be based on an amount of historical data that is sufficient to derive robust, accurate estimates. (3) LGDs provided by external sources may also be used by institutions, provided they can be shown to be relevant for the bank’s portfolio. 13.39 Banks must establish a hierarchy ranking their preferred sources for PDs and LGDs, in order to avoid the cherry-picking of parameters. 51 Market-implied PDs are not acceptable. 52 LGD should be interpreted in this context as 1 – recovery rate.