According to point 55 of Article 4(1) of Regulations (EU) No 575/2013 (CRR) ‘Loss given default’ or ‘LGD’ means the ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default.
In case the exposure is fully-off balance at the moment of default and there are no additional drawings after default, both the numerator and the denominator of the LGD will be equal to zero. This means that the LGD cannot be calculate using the definition stated above. Should the realized LGD be set equal to zero in this case?
Article 181(1)(a) of Regulations (EU) No 575/2013 (CRR) specifies that LGDs shall be estimated on the basis of the average realized LGD by facility grade or pool using all observed defaults.
In case a facility is fully off-balance at the moment of default and there are no additional drawings after default, the LGD can not be calculated following the definition in point 55 of Article 4(1). Because both the numerator and denominator are equal to zero. However, Article 181(1)(a) of Regulations (EU) No 575/2013 (CRR) requires to calculate LGD for all observed defaults.
For the purpose of Article 181(1)(a) and calculating the realized LGD for exposures fully off-balance at the moment of default (i.e., no on-balance exposure) and with no additional drawings, the following options can be considered:
The situation where there is no on-balance exposure at the moment of default and no post default drawings is illustrated by two example below:
A simple example is a revolving exposure, which happens to be fully off-balance at the moment of default and there are no post default drawings.
Suppose a bank guarantee is provided by the institution to the obligor without any other products. In other words, the bank guarantee is the sole exposure the institution has towards the obligor. Suppose further that the obligor defaults and the guarantee is not claimed by the beneficiary after default (i.e., no additional drawings after default).