exposure at default ead is the total value a bank is exposed to when a loan defaults using the internal ratings based irb approach financial institutions calculate their risk banks often use internal risk management default models to estimate respective ead systems outside of the banking industry ead is known as credit exposure 
understanding exposure at defaultead is the predicted amount of loss a bank may be exposed to when a debtor defaults on a loan banks often calculate an ead value for each loan and then use these figures to determine their overall default risk ead is a dynamic number that changes as a borrower repays a lender there are two methods to determine exposure at default regulators use the first approach which is called foundation internal ratings based f irb this approach to determining exposure at risk includes forward valuations and commitment detail though it omits the value of any guarantees collateral or security the second method called advanced internal ratings based a irb is more flexible and is used by banking institutions banks must disclose their risk exposure a bank will base this figure on data and internal analysis such as borrower characteristics and product type ead along with loss given default lgd and the probability of default pd are used to calculate the credit risk capital of financial institutions banks often calculate an ead value for each loan and then use these figures to determine their overall default risk special considerationspd analysis is a method used by larger institutions to calculate their expected loss a pd is assigned to each risk measure and represents as a percentage the likelihood of default a pd is typically measured by assessing past due loans it is calculated by running a migration analysis of similarly rated loans the calculation is for a specific time frame and measures the percentage of loans that default the pd is then assigned to the risk level and each risk level has one pd percentage lgd unique to the banking industry or segment measures the expected loss and is shown as a percentage lgd represents the amount unrecovered by the lender after selling the underlying asset if a borrower defaults on a loan an accurate lgd variable may be difficult to determine if portfolio losses differ from what was expected an inaccurate lgd may also be due to the segment being statistically small industry lgds are typically available from third party lenders also pd and lgd numbers are usually valid throughout an economic cycle however lenders will re evaluate with changes to the market or portfolio composition changes that may trigger reevaluation include economic recovery recession and mergers a bank may calculate its expected loss by multiplying the variable ead with the pd and the lgd ead x pd x lgd expected lossexposure at risk examplemodern economies have become increasingly intertwined what happens in one country is more likely to financially impact others especially when a wide scale calamity is experienced consider the impact of lehman brothers bankruptcy filing in 2008 as a result of subprime mortgage loans that heightened the company s exposure at default lehman brothers credit rating was downgraded forcing the federal reserve to summon several banks to negotiate the financing for its reorganization congress also passed a 700 billion rescue bill in response to the widespread financial risk the collapse of the firm could have 1in response to the credit crisis of 2007 2008 the banking sector adopted international regulations to lessen its exposure to default the basel committee on banking supervision s goal is to improve the banking sector s ability to deal with financial stress 2 through improving risk management and bank transparency the international accord hopes to avoid a domino effect of failing financial institutions 