Loss Given Default Modelling Under The Asymptotic Single Risk Factor Assumption

The proposals of the Basel Committee on Banking Supervision for the revision of minimum requirements for bank's risk capital leave the quantification of Loss-Given-Default (LGD) parameter used for capital calculation unspecified. This paper proposes a new methodology for incorporating LGD parameter explicitly into the Basel risk weight function. Numerical examples based on the new methodology are compared to the current proposals of the Basel committee on Banking Supervision. In particular, a number of interested parties including industry associations and national supervisors have asked the Committee to further elaborate on the so-called "Downturn LGD" standard described in the proposals, which requires that estimated downturn LGD must "Reflect economic downturn conditions where necessary to capture the relevant risks."