Credit-risk measure estimating the average loss a lender expects after combining default probability, exposure, and loss severity.
Expected loss (EL) is the average credit loss a lender or investor expects over a period after combining how likely default is, how large the exposure will be, and how severe the loss will be if default occurs.
Expected loss matters because credit risk is not just about whether borrowers default. It is also about how much is outstanding at default and how much can still be recovered. EL gives lenders a practical way to price risk, set reserves, compare portfolios, and test whether a credit spread or interest rate is compensating them for likely losses.
The standard credit-risk version is:
Where:
| Component | Meaning |
| — | — |
| Probability of Default (PD) | Chance the borrower defaults |
| Exposure at Default (EAD) | Amount outstanding when default happens |
| Loss Given Default (LGD) | Portion of that exposure not recovered |
Expected loss is an average, not a guaranteed realized outcome on a single loan. One borrower may never default, while another may default with a much larger or smaller loss than modeled. EL is most useful across portfolios, pricing decisions, capital planning, and loan-loss provisioning where institutions care about average loss behavior.
Suppose a lender estimates:
PD = 3%
EAD = $200,000
LGD = 40%
Then:
The lender’s expected loss is $2,400. That does not mean the loan will definitely lose $2,400. It means that, on average, this is the modeled credit loss contribution.
Default rate tracks how often borrowers default. Expected loss adds exposure size and loss severity, so it is more useful for economic loss measurement.
LGD only measures severity after default. EL combines severity with the probability that default happens and the amount exposed.
Expected loss is the average modeled loss. Unexpected loss refers to volatility around that average and matters more for capital buffers and stress analysis.
Banks use it in underwriting, pricing, portfolio monitoring, and reserve analysis.
Credit investors use it to compare spread compensation against modeled default losses.
Risk teams use it to connect PD, EAD, and LGD assumptions into a single loss estimate.
Probability of Default (PD): Likelihood that the borrower defaults.
Exposure at Default (EAD): Amount exposed when default happens.
Loss Given Default (LGD)"): Share of exposure that is ultimately lost.
Recovery Rate: Portion of exposure recovered after default.