Credit risk key metrics

Let's review the key terms for credit risk.

Exposure at default

This is the amount that a bank is exposed to when a counterparty defaults. It could be equal to the outstanding amount on a fixed loan. In the case of limits, this needs to be assessed based on the drawn and undrawn components. Having a high exposure at default (EAD) doesn't necessarily mean that the bank would lose an equivalent amount. The amount lost could be less, equal, or even higher than the EAD. The loss given default calculation would help the bank assess the loss in case of a certain EAD. The regulators are concerned about the bank's overall EAD figure and also the EAD figures, to some specific sectors, which may point to a credit risk situation developing.

Probability of default

This is the likelihood of default over a given time period. It is usually calculated as the probability of default (PD) over a year, or a point in time PD. Organizations using advanced approach modeling have to use a standard...