Financial regulators compute the recovery rate as the unconditional expected value of collateral, without conditioning on the default event.

Judged as of 2019 against the regulatory frameworks (Basel or IFRS 9 rules on LGD or recovery). True: the regulatory or industry methods Taleb refers to compute recovery or collateral value as an unconditional expected value, without conditioning on default. Mostly true: some major frameworks do this, but others partly address it. Mixed: frameworks formally require conditioning on default, for example the downturn-LGD requirement under Basel II/III, but common practice or some models in effect use unconditional values. Mostly false: the key frameworks explicitly require default-conditioned or downturn values, and the claim rests only on isolated practices. False: the regulators are shown to condition on default, and no relevant practice of using unconditional values exists.

Set before the research began.

1. E1 Credit risk – internal ratings-based approach | Bank for International Settlements Bank for International Settlements · 1 January 2026

   “Under such conditions default rates are expected to be high so that if recovery rates are negatively related to default rates, LGD parameters should embed forecasts of future recovery rates that are lower than those expected during more neutral conditions.”

2. E2 International Convergence of Capital Measurement and Capital Standards Bank for International Settlements (Basel Committee on Banking Supervision) · June 2006

   “LGD estimates must be grounded in historical recovery rates and, when applicable, must not solely be based on the collateral’s estimated market value.”

3. E3 Final Report on Guidelines on LGD estimates under downturn ... European Banking Authority · 6 March 2019

   “This framework put an emphasis on the correlation between default rates and recovery rates; in fact, if no material dependencies between default rates and recovery rates are identified, the downturn LGD estimates may be based on the long-run average LGD.”

The Basel II framework (E3) requires that LGD estimates be grounded in historical recovery rates and not rest solely on the collateral's estimated market value. Current Basel IRB guidance (E1, dated 2026) says LGD parameters should embed lower downturn recovery rates where recoveries move inversely with default rates, though this text post-dates the 2019 judging date. The EBA's 2019 downturn-LGD guidelines (E4) likewise stress the link between default rates and recovery rates, which indicates that the key frameworks require recovery estimates to reflect downturn conditions where the two are related, while allowing the long-run average LGD where no material dependency is found. E4 does let firms fall back on long-run average LGD when no material dependency is found, which leaves some room for estimates that are less conditioned. However, no evidence shows regulators computing recovery as the unconditional expected value of collateral.