Loss Distribution Approach

The Loss Distribution Approach (LDA) is a method used by financial institutions to estimate potential losses from risks like fraud, system failures, or natural disasters. It involves analyzing past loss data to understand how often losses of different sizes occur and then modeling these losses as a probabilistic distribution. By combining this information, lenders can assess the likelihood and possible magnitude of future losses, helping them set aside sufficient capital reserves. Essentially, LDA provides a statistical way to manage and prepare for unpredictable risks, ensuring financial stability.