Exposure at Default (EAD) isn’t just banking jargon—it’s one of the most important risk measures shaping how Australian lenders operate and how much borrowers pay for credit. With regulatory changes in 2025 and a renewed focus on credit risk, understanding EAD is more important than ever for individuals, businesses, and investors navigating Australia’s evolving lending landscape.
What is Exposure at Default (EAD)?
EAD is the total value a lender is exposed to if a borrower defaults on a loan or credit facility at a given point in time. It’s a central component in the calculation of regulatory capital requirements under the Basel III framework, which Australia’s banks are required to follow. EAD determines how much money banks must set aside to cover potential losses and directly influences interest rates, lending limits, and risk assessments.
For example, if a business has a $1 million loan and $200,000 outstanding on a line of credit, the EAD could be as high as $1.2 million if the borrower defaults tomorrow. However, EAD isn’t always just the current balance—it can include undrawn credit lines, contingent liabilities, and off-balance-sheet exposures.
2025 Regulatory Updates: APRA’s Push for Greater Precision
The Australian Prudential Regulation Authority (APRA) is rolling out updated capital framework rules in 2025, in line with the global Basel III reforms. These updates are designed to make EAD calculations more accurate and risk-sensitive, with particular attention to:
- Undrawn Commitments: Banks must now use more granular credit conversion factors (CCFs) to estimate the amount likely to be drawn down before a default event. For example, revolving retail facilities (like credit cards) now have higher CCFs to reflect real-world borrower behaviour.
- Off-Balance-Sheet Exposures: Guarantees, letters of credit, and other contingent liabilities must be more rigorously assessed and included in EAD calculations.
- Small Business Lending: APRA’s new guidance encourages banks to use historical drawdown patterns and borrower characteristics to better estimate EAD, reducing the risk of underestimating exposure in times of economic stress.
For borrowers, this means banks may become more cautious with undrawn facilities, and interest margins could shift as lenders recalibrate their risk models.
How EAD Affects Borrowers and Lenders
The way EAD is calculated has real-world consequences for both sides of the lending table:
- Borrowers: EAD influences how much capital a bank must hold against your loan, affecting your interest rate and the terms you’re offered. If you have a large undrawn credit facility, the bank’s perceived risk (and your cost of borrowing) could rise.
- Lenders: Accurate EAD measurement ensures banks maintain enough capital to absorb losses—especially crucial in a volatile economic environment. The 2025 changes mean more data-driven, tailored credit assessments, but also greater scrutiny of complex lending arrangements.
Take, for instance, an SME with a $500,000 business loan and a $100,000 overdraft facility. Under the new rules, the bank might calculate EAD at $570,000 (assuming a 70% CCF on the undrawn overdraft), rather than just the outstanding balances. This could affect the SME’s borrowing costs and the bank’s willingness to extend further credit.
Real-World Examples: EAD in Practice
- Home Loans: For most residential mortgages, EAD is typically the outstanding loan balance. However, if you have a redraw facility, the available undrawn amount may be partially included in the EAD calculation.
- Credit Cards: Even if you haven’t maxed out your card, banks use statistical models to estimate how much of your credit limit you might draw down before a default, often assuming 75-90% of the limit is at risk.
- Commercial Lending: Complex facilities like trade finance lines and contingent liabilities (e.g., guarantees) can significantly increase a bank’s EAD and, in turn, influence lending appetite and pricing.
Why EAD Matters in 2025 and Beyond
As APRA tightens risk-based capital rules and banks refine their credit risk models, EAD will be under the microscope. This affects loan pricing, availability of credit, and the resilience of Australia’s financial system. For borrowers, understanding how your facilities are viewed through the lens of EAD can help you negotiate better terms and anticipate changes in lending conditions.
