Risk Parameter Modeling: The Role of Correlation in Downturn Loss Given Default Estimation

| Point of View

Within the banking industry, reduced recovery rates during economic downturns are often a source of unexpected losses. This is because failure to identify the relationship between loss rates and key risk drivers can cause banking institutions to underestimate their capital needs. What’s more, data limitations further complicate the loss given default (LGD) modeling process. That’s why it’s necessary to calculate a downturn LGD in order to ensure that banks have adequate capital and liquidity.