The concepts of expected and unexpected losses are often used to manage credit risk. The expected loss on a transaction is the mathematical expectation of the possible loss. Generally, it is usually calculated as the product of:.

This way of calculating the expected loss is purely operational: it is usually the responsibility of different departments to estimate the probabilities of default, risk exposures, and losses in the event of default.

The expected loss is additive: the expected loss in a loan portfolio is the sum of the expected losses of the loans that comprise it.

Financial institutions are required by their regulators to maintain reserves (or provisions) to cover them.

A random variable, such as the loss of a loan portfolio, apart from a mean (collected by the expected loss) also has a variance that can cause the actual loss in a period of time to substantially exceed the expected one. The unexpected loss captures this variation and is usually defined as a given percentile of the loss distribution.

Generally, banking regulators require that financial institutions have sufficient capital to be able to absorb unexpected losses of a given size. The Basel II regulatory framework establishes standards to estimate the size of said capital buffer.

Unexpected losses are not additive since they depend largely on the correlation between the different loans that make up a portfolio.

Credit risk is calculated through three fundamental components:[2]​.

The types of credit risk are classified as follows[3]​.

La norma que regula a gestión del riesgo de crédito para entidades de crédito en España es la Circular 03/2008 del Banco de España,[4]​ según la cual, las entidades de crédito están obligadas a cubrir tanto sus pérdidas esperadas como las inesperadas.

Management of expected losses

In accordance with Annex IX of Circular 04/2004 of the Bank of Spain, every entity must classify all the risks it has assumed into one of these five categories:

Failed risks must be written off the balance sheet and do not require any further coverage. Regarding the others:

The models to estimate the expected loss must be approved by the Bank of Spain.

Management of unexpected losses

Unexpected demands (and, therefore, not covered by provisions) must be covered financially: the Bank of Spain requires in its Circular 03/2008 that entities maintain Computable Own Resources (capital) equal to or greater than the Minimum Capital Requirements, which, in the case of credit risk, amount to 8% of the exposure to credit risk weighted by type of risk.

The concepts of expected and unexpected losses are often used to manage credit risk. The expected loss on a transaction is the mathematical expectation of the possible loss. Generally, it is usually calculated as the product of:.

This way of calculating the expected loss is purely operational: it is usually the responsibility of different departments to estimate the probabilities of default, risk exposures, and losses in the event of default.

The expected loss is additive: the expected loss in a loan portfolio is the sum of the expected losses of the loans that comprise it.

Financial institutions are required by their regulators to maintain reserves (or provisions) to cover them.

A random variable, such as the loss of a loan portfolio, apart from a mean (collected by the expected loss) also has a variance that can cause the actual loss in a period of time to substantially exceed the expected one. The unexpected loss captures this variation and is usually defined as a given percentile of the loss distribution.

Generally, banking regulators require that financial institutions have sufficient capital to be able to absorb unexpected losses of a given size. The Basel II regulatory framework establishes standards to estimate the size of said capital buffer.

Unexpected losses are not additive since they depend largely on the correlation between the different loans that make up a portfolio.

Credit risk is calculated through three fundamental components:[2]​.

The types of credit risk are classified as follows[3]​.

La norma que regula a gestión del riesgo de crédito para entidades de crédito en España es la Circular 03/2008 del Banco de España,[4]​ según la cual, las entidades de crédito están obligadas a cubrir tanto sus pérdidas esperadas como las inesperadas.

Management of expected losses

In accordance with Annex IX of Circular 04/2004 of the Bank of Spain, every entity must classify all the risks it has assumed into one of these five categories:

Failed risks must be written off the balance sheet and do not require any further coverage. Regarding the others:

The models to estimate the expected loss must be approved by the Bank of Spain.

Management of unexpected losses

Unexpected demands (and, therefore, not covered by provisions) must be covered financially: the Bank of Spain requires in its Circular 03/2008 that entities maintain Computable Own Resources (capital) equal to or greater than the Minimum Capital Requirements, which, in the case of credit risk, amount to 8% of the exposure to credit risk weighted by type of risk.