Definition
Probability of Default (PD)
Probability of Default is the estimated likelihood that a borrower will fail to meet its obligations over a given period, a key input to credit-loss models.
PD is one of three building blocks of the expected credit loss model, alongside loss given default and exposure at default. Lenders estimate PD from borrower ratings, historical default data and forward-looking economic scenarios.
A higher PD raises the provisions a lender must hold under Ind AS, increasing credit cost. Banks and NBFCs build PD models by segment and rating, and the RBI's advanced approaches under Basel also allow internal PD estimates for capital calculation, subject to approval.
Related terms
- Credit CostCredit cost is the provisioning a bank or NBFC books for bad and doubtful loans during a period, usually expressed as a percentage of average advances.
- Credit RatingA credit rating is an independent agency's assessment of a borrower's ability to repay debt, ranging from AAA (safest) down to D (default).
- Expected Credit Loss (ECL)Expected Credit Loss is a forward-looking provisioning model under Ind AS 109 that estimates likely loan losses based on probability of default, not just incurred defaults.
- Loss Given Default (LGD)Loss Given Default is the share of an exposure a lender expects to lose if a borrower defaults, after accounting for collateral and recoveries.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.