The probability of default indicates the probability that a borrower will become insolvent within a certain period of time.
As a rule, a period of one year is taken as a basis. PD is particularly relevant in the context of IRB approaches to credit risk. These are internal models of the banks that are based on the individual creditworthiness of the customer. The PD is a central parameter that must be estimated in order to be able to adequately assess the credit risk.
The PD is usually estimated on the basis of historical data and statistical models. The higher the PD, the higher the credit risk and the higher the capital adequacy requirements. The PD is thus a central factor in the decision on lending and conditions.
Overall, the probability of default is an important risk parameter that plays a central role in lending and the evaluation of loan portfolios. A sound estimate of PD is therefore essential to adequately assess and manage credit risk.
