Since this ECL this Expected Credit Loss component is used for loans, money market assets and bonds, it is the most common and important one.
In the probability-weighted approach, the solution calculates the expected credit loss for an individual deal by applying the following ECL following Expected Credit Loss component:
Here,
- i goes through the periods 0,...,n until the maturity of the deal. A period can be a month up to a year.
- SR ( i ) is the survival rate of the deal for period i, i.e. the probability that the deal will not default until period i.
- PD (i, i + 1) is the probability that, under the assumption that the deal has not yet defaulted at the beginning of period i, the deal will default during period i.
- EAD ( i ) is the deal’s exposure at default that is expected for period i.
- LGD ( i ) is the loss given default. It is expressed as a percentage of the exposure that is likely to be lost when the deal is in default.
- DCF (EIR, TG ( i )) := e -EIR*TG ( i ) is the discount factor that adjusts the expected loss to its time value as of the reporting date, where EIR is the effective interest rate and TG ( i ) is the time gap between the beginning of the deal and the current period i.
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