[{"data":1,"prerenderedAt":-1},["ShallowReactive",2],{"detail-sidebar-cat-1-en-105":3,"doc-seo-253769-105":53,"doc-detail-253769-en":126},{"code":4,"msg":5,"data":6},0,"success",[7,14,19,24,29,34,39,44,49],{"id":8,"doc_module":9,"doc_module_name":10,"category_name":11,"show_sort_weight":12,"slug":13},11,1,"Template","Presentations",90,"presentations",{"id":15,"doc_module":9,"doc_module_name":10,"category_name":16,"show_sort_weight":17,"slug":18},12,"Resumes",80,"resumes",{"id":20,"doc_module":9,"doc_module_name":10,"category_name":21,"show_sort_weight":22,"slug":23},14,"Invoices",70,"invoices",{"id":25,"doc_module":9,"doc_module_name":10,"category_name":26,"show_sort_weight":27,"slug":28},15,"Posters",60,"posters",{"id":30,"doc_module":9,"doc_module_name":10,"category_name":31,"show_sort_weight":32,"slug":33},16,"Social Media",50,"social-media",{"id":35,"doc_module":9,"doc_module_name":10,"category_name":36,"show_sort_weight":37,"slug":38},17,"Forms",40,"forms",{"id":40,"doc_module":9,"doc_module_name":10,"category_name":41,"show_sort_weight":42,"slug":43},18,"Letters",30,"letters",{"id":45,"doc_module":9,"doc_module_name":10,"category_name":46,"show_sort_weight":47,"slug":48},21,"Paper Templates",5,"papers-templates",{"id":50,"doc_module":9,"doc_module_name":10,"category_name":51,"show_sort_weight":4,"slug":52},158,"General","general-158",{"code":4,"msg":54,"data":55},"ok",{"site_id":56,"language":57,"slug":58,"title":59,"keywords":60,"description":61,"schema_data":62,"social_meta":119,"head_meta":121,"extra_data":123,"updated_unix":125},105,"en","a-cost-of-capital-approach-to-determining-the-lgd-discount-rate","A cost of capital approach to determining the LGD discount rate","","Loss Given Default (LGD) is a central risk parameter used to determine a bank’s regulatory capital. During LGD estimation, realised recovery cash flows must be discounted using a rate that reflects both the time value of money and a risk premium capturing “undiversifiable risk” in recoveries. After reviewing prior methods, the paper introduces a cost of capital approach drawn from Solvency II: infer a discount rate from a market-consistent price of a portfolio of defaulted loans. Empirical results on South African mortgage and personal loan data identify mean and variance of recoveries and the bank’s cost of capital over the risk-free rate as key drivers.",{"@graph":63,"@context":118},[64,80,101],{"@type":65,"itemListElement":66},"BreadcrumbList",[67,71,74,77],{"item":68,"name":69,"@type":70,"position":9},"https://docshare.wps.com","Home","ListItem",{"item":72,"name":10,"@type":70,"position":73},"https://docshare.wps.com/template/",2,{"item":75,"name":16,"@type":70,"position":76},"https://docshare.wps.com/template/resumes/",3,{"item":78,"name":59,"@type":70,"position":79},"https://docshare.wps.com/template/a-cost-of-capital-approach-to-determining-the-lgd-discount-rate/253769/",4,{"url":78,"name":59,"@type":81,"image":82,"author":87,"headline":59,"publisher":90,"fileFormat":93,"inLanguage":57,"description":61,"dateModified":94,"datePublished":95,"encodingFormat":93,"isAccessibleForFree":96,"interactionStatistic":97},"DigitalDocument",{"url":83,"@type":84,"width":85,"height":86},"https://docshare.wps.com/thumbnails/a-cost-of-capital-approach-to-determining-the-lgd-discount-rate/253769.png","ImageObject",442,249,{"name":88,"@type":89},"Himbo","Person",{"url":68,"name":91,"@type":92},"DocShare","Organization","application/pdf","2026-10-17","2026-09-13",true,{"@type":98,"interactionType":99,"userInteractionCount":9},"InteractionCounter",{"@type":100},"ViewAction",{"@type":102,"mainEntity":103},"FAQPage",[104,110,114],{"name":105,"@type":106,"acceptedAnswer":107},"Why is the LGD discount rate important in regulatory capital modelling?","Question",{"text":108,"@type":109},"LGD is a key risk parameter for regulatory capital, and recovery cash flows must be discounted using a rate that captures both the time value of money and an appropriate risk premium reflecting undiversifiable risk.","Answer",{"name":111,"@type":106,"acceptedAnswer":112},"What new approach does the paper propose to determine the LGD discount rate?",{"text":113,"@type":109},"It proposes a cost of capital approach inspired by Solvency II, estimating a market-consistent price for a portfolio of defaulted loans and inferring the associated discount rate.",{"name":115,"@type":106,"acceptedAnswer":116},"What drivers does the method identify for the discount rate?",{"text":117,"@type":109},"The results indicate that the mean and variance of recovery outcomes, together with the bank’s cost of capital in excess of the risk-free rate, drive the discount rate.","https://schema.org",{"og:url":78,"og:type":120,"og:title":59,"og:site_name":91,"og:description":61},"article",{"robots":122,"canonical":78},"index,follow",{"doc_id":124,"site_id":56},253769,1792227498,{"code":4,"msg":5,"data":127},{"doc_id":124,"user_id":128,"nickname":88,"user_avatar":129,"doc_module":9,"category_id":15,"category_name":16,"doc_title":59,"doc_description":61,"doc_content":130,"file_id":131,"file_url":132,"file_type":133,"file_size":134,"view_count":9,"is_deleted":4,"is_public":9,"is_downloadable":9,"audit_status":9,"page_count":135,"language":136,"language_code":57,"site_id":56,"html_lang":57,"table_of_contents":137,"faqs":138,"seo_title":139,"seo_description":61,"update_tm":140,"read_time":141},687197100911,"https://ap-avatar.wpscdn.com/avatar/a000239b6f1da00475?x-image-process=image/resize,m_fixed,w_180,h_180&k=1785132997149421697","SOUTH AFRICAN ACTUARIAL JOURNAL  \nSAAJ 25 (2025) 93–117  \n[https://dx.doi.org/10.4314/saaj.v25i1.4](https://dx.doi.org/10.4314/saaj.v25i1.4)  \nA cost of capital approach to determining the LGD discount rate  \nBy J Larney, ABotha, GL Grobler and H Raubenheimer  \nSubmission date 29 July 2025 Acceptance date 4 October 2025  \nABSTRACT  \nLoss Given Default (LGD) is a key risk parameter in determining a bank’s regulatory capital. During LGD estimation, realised recovery cash flows are to be discounted at an appropriate rate. Regulatory guidance mandates that this rate should allow for the time value of money, as well as include a risk premium that reflects the “undiversifiable risk” within these recoveries. Having extensively reviewed earlier methods of determining this rate, we propose a new approach that is inspired by the cost of capital approach from the Solvency II regulatory regime. Our method involves estimating a market-consistent price (that reflects market information) for a portfolio of defaulted loans, from which an associated discount rate may be inferred. We apply this method to mortgage and personal loans data from a large South African bank. The results reveal the main drivers of the discount rate to be the mean and variance of these recoveries, as well as the bank’s cost of capital in excess of the risk-free rate. Our method therefore produces a discount rate that reflects both the undiversifiable risk of recovery recoveries and the time value of money, thereby satisfying regulatory requirements. This work can subsequently enhance the LGD component within the modelling of both regulatory and economic capital.  \nKEYWORDS  \nLoss given default, discount rate, risk premium, cost of capital, solvency  \nCONTACT DETAILS  \nJanette Larney, Centre for Business Mathematics and Informatics, North-West University, Private Bag X6001, Potchefstroom, 2520; National Institute for Theoretical and Computational Sciences (NITheCS), Stellenbosch, 7600; Email: [janette.larney@nwu.ac.za](janette.larney@nwu.ac.za)  \nArno Botha, Centre for Business Mathematics and Informatics, North-West University, Private Bag X6001, Potchefstroom, 2520; NITheCS, Stellenbosch, 7600  \nGerrit Lodewicus Grobler, Department of Statistics, North-West University, Private Bag X6001, Potchefstroom, 2520  \nHelgard Raubenheimer, Centre for Business Mathematics and Informatics, North-West University, Private Bag X6001, Potchefstroom, 2520; NITheCS, Stellenbosch, 7600  \n1. INTRODUCTION  \n1.1 One of the key risk parameters used in determining a bank’s regulatory capital under the Basel II Capital Accord from the Basel Committee on Banking Supervision (BCBS)(2006) is the loss given default (LGD). Denoted as the random variable L ∈[0,1], a loan’s LGD is the fraction of its balance Bτd (or the exposure at default (EAD)) that was eventually lost on a defaulted account, as at the time of default τd. The LGD is often described as the“economic loss” on a financial instrument, which includes both material discount effects and material direct/indirect collection costs; see BCBS (2006: §460), itself corroborated by the European Parliament (2006) . In nursing the strained relationship between the bank and the defaulted borrower back to health, collection staff can pursue a variety of remedial actions during this so-called resolution/workout period. From Van Gestel & Baesens (2009: 26–8), Finlay (2010: 11–3), and Botha (2021: §2.2), these remedial actions commonly include:  \n1. temporarily lowering instalments and/or zeroing interest rates;  \n2. extending a payment “holiday” during which instalments are suspended; and  \n3. restructuring the loan in the borrower’s favour.  \nSuccessful collection efforts imply the distressed borrower repaying a newly-negotiated stream of cash flows over time and/or lump sums, both of which are called receipts in this work. These receipts should diminish the arrears balance and decrease the delinquency, ultimately “curing” the loan back to health; re","cbCaie1MLvFyRMWR","https://ap.wps.com/l/cbCaie1MLvFyRMWR","pdf",2957461,25,"English","# 1. INTRODUCTION\n## 1.1 Basel II and the role of LGD\n## 1.2 Basel IRB and common LGD estimation methods","[{\"question\":\"Why is the LGD discount rate important in regulatory capital modelling?\",\"answer\":\"LGD is a key risk parameter for regulatory capital, and recovery cash flows must be discounted using a rate that captures both the time value of money and an appropriate risk premium reflecting undiversifiable risk.\"},{\"question\":\"What new approach does the paper propose to determine the LGD discount rate?\",\"answer\":\"It proposes a cost of capital approach inspired by Solvency II, estimating a market-consistent price for a portfolio of defaulted loans and inferring the associated discount rate.\"},{\"question\":\"What drivers does the method identify for the discount rate?\",\"answer\":\"The results indicate that the mean and variance of recovery outcomes, together with the bank’s cost of capital in excess of the risk-free rate, drive the discount rate.\"}]","A cost of capital approach to determining the LGD discount rate | PDF",1789269864,9]