Explanation:
Expected Loss (EL) is calculated as Probability of Default (PD) × Loss Given Default (LGD) × Exposure at Default (EAD). Base scenario EL: Total EAD = USD 1,000,000,000. PD for rating B = 3%. LGD in normal conditions = 100% - 60% = 40%. EL (Base) = 1,000,000,000 × 0.03 × 0.40 = USD 12,000,000.
Stressed scenario EL: LGD in stress conditions = 100% - 40% = 60%. Half the clients remain rating B: EAD = 500,000,000, PD = 3%. EL (Stress B) = 500,000,000 × 0.03 × 0.60 = USD 9,000,000. Half the clients downgrade to rating C: EAD = 500,000,000, PD = 25%. EL (Stress C) = 500,000,000 × 0.25 × 0.60 = USD 75,000,000. Total EL (Stressed) = 9,000,000 + 75,000,000 = USD 84,000,000.
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Q.53 An investment bank has a USD1,000,000,000 portfolio of senior unsecured loans evenly distributed between 10 different clients, each with an internal rating B. The CRO of the bank wants to stress the loan portfolio under a scenario of an economic slowdown with the GDP dropping by 2% and unemployment increasing by 1%. Based on the prior experience, the CRO knows the economic slowdown scenario will negatively impact the credit quality of the borrowers, and lead to a rating deterioration from B to C for half of the clients. The recovery rates of senior unsecured facilities are assumed to be 60% in normal conditions and 40% in stress conditions.
| Credit Rating | PD |
|---|---|
| A | 0% |
| B | 3% |
| C | 25% |
| D | 100% |
What is the bank’s loan portfolio expected loss in both the base and the stressed scenarios?
A
Loss (Base scenario) = USD12,000,000; Loss (Stressed scenario) = $56,000,000
B
Loss (Base scenario) = USD12,000,000; Loss (Stressed scenario) = $84,000,000.
C
Loss (Base scenario) = USD18,000,000; Loss (Stressed scenario) = $56,000,000.
D
Loss (Base scenario) = USD18,000,000; Loss (Stressed scenario) = $84,000,000.
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