PD, LGD and EAD: The Three Numbers That Price Your Loan
ADS Team
Author
August 22, 2026
3 months ago
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In short: Banks price credit risk using three inputs: the probability you default (PD), how much they would lose if you did (LGD), and how much you owe at that point (EAD). Multiplied together they give expected loss - the amount the bank must price into your rate before any profit.
Key takeaways
- Expected loss = PD x LGD x EAD.
- A larger deposit reduces LGD, which is why LVR drives pricing so strongly.
- These inputs also determine regulatory capital, which is a separate cost.
- This framework underpins IFRS 9 provisioning as well as pricing.
The three inputs
| Input | Meaning | What reduces it |
|---|---|---|
| PD | Probability of default over a period | Strong credit history, stable income |
| LGD | Proportion lost if default occurs | Lower LVR, better security, LMI |
| EAD | Exposure at the time of default | Amortisation, lower limits |
A worked example
A $600,000 loan at 60% LVR with a 0.5% PD and 20% LGD:
Expected loss = 0.005 × 0.20 × $600,000 = $600 a year, or 0.10% of the loan.
The same borrower at 95% LVR might have an LGD of 40%: 0.005 × 0.40 × $600,000 = $1,200, or 0.20%. The deposit alone doubles the expected loss the bank must price for - which is precisely why low-LVR borrowers get sharper rates.
Why it matters to you
Understanding this reframes rate negotiation. You are not asking a lender to be generous; you are demonstrating that your PD and LGD are lower than their standard assumption - through a larger deposit, clean conduct, stable income and lower LVR after repayments.
That is why a revaluation after paying down principal is often the most effective repricing argument available.
Frequently asked questions
Does LMI reduce my rate?
It reduces the bank's LGD, which is why lending above 80% is possible at all. It does not usually produce a rate below the sub-80% pricing, because the risk is still higher.
Is this the same as my credit score?
Related but not identical. Your credit score is one input into the bank's internal PD estimate, alongside income, LVR, product type and its own portfolio data.
Do all banks use this?
Larger banks with advanced accreditation model these inputs internally; smaller lenders use standardised risk weights. That difference is why major banks can price sharply on low-LVR lending.
Related reading
- LVR Explained: Why 80% Is the Magic Number
- Where Banks Actually Get the Money They Lend You
- How Swap Rates Determine Your Fixed Home Loan Rate
Sources
- Prudential Standard APS 113 Capital Adequacy: IRB approach — APRA
- AASB 9 Financial Instruments — Australian Accounting Standards Board
Information current as at 2 September 2026.
General advice warning: This article contains general information only. It does not take into account your objectives, financial situation or needs, and it is not personal credit or financial advice. Consider whether it is appropriate for you and seek advice from a licensed credit representative before acting.
Any interest rate shown is an example only and is not an offer of credit. Where a rate is quoted, the applicable comparison rate is available from the relevant lender and should be considered alongside it.
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