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CMA Final · Risk Management in Banking and Insurance · Introduction to Risk Management

A bank has a corporate loan of Rs 200 crore. The borrower's one-year probability of default is 2%, loss given default is 45% and exposure at default is the full loan amount. What is the bank's expected loss on this loan?

Expected loss is Rs 1.8 crore, calculated as probability of default 2% times loss given default 45% times exposure at default Rs 200 crore. Using only PD and exposure gives Rs 4 crore, which wrongly ignores the recovery assumption embedded in LGD.

  1. ARs 1.8 croreCorrect
  2. BRs 4.0 crore
  3. CRs 9.0 crore
  4. DRs 0.9 crore

Explanation

Expected loss = PD x LGD x EAD = 0.02 x 0.45 x 200 = Rs 1.8 crore. Rs 4.0 crore ignores LGD (0.02 x 200). Rs 9.0 crore ignores PD (0.45 x 200 x 0.10 is not applicable; it multiplies LGD and EAD incorrectly). Rs 0.9 crore results from halving the correct figure.

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