First loss deductible

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First loss deductible relates to the amount of recourse a bank is liable to in the event of securitised loans going bad. When a bank enters into a securitisation, the securitisation agreement will most likely include a clause to the amount of bad debts / unpaid items that the bank is liable for. It is basically a protection for the buyer of the securities in that the issuing bank will stand losses of up to a set amount or percentage.

For example, if Bank A securitises €100m of assets, they may typically include a first loss deductible of 2%, meaning that they will be liable for up to €2m of losses incurred as a result of the loans going bad.

Banks are required to then deduct the first loss provision from their capital before calculating their solvency ratios.