Example of a Capital Charge on a Project Loan Portfolio

Basel II Risk
Supervisory Rating Basel I Risk Weights - IRB Target Capital
Category Weights Approach - Ex 1 Ratio

AAA to A- 100% 75% 8%

BBB+ to BBB- 100% 75% 8%
BB+ 100% 150% 8%
BB 100% 150% 8%
BB- 100% 150% 8%

Increase in Regulatory Capital <(9.6%-8%)/8%> 20%

Basel II: Loan Economics

Loss Given
3-m LIBOR 5% Default (LGD)
Target ROE (pre-
Loan Spread 1.80% tax)
Debt-funding cost - Basel II Capital
LIBOR 5% ratio - Target

Under Basel II
Under Basel I Hold Spread
Interest Income 6.80% 6.80%

Expenses
Administrative / Operating 0.10% 0.10%
Expense Loan Loss (PD = 2%) 0.50% 0.50%

Cost of Funds
Regulatory Risk weight 100% 150%
Required Capital Ratio 8.00% 12.00%
Debt Charge (Interest) 4.60% 4.40%
Equity (Capital) Charge 1.60% 2.40%

Economic Return 0.00% -0.60%

Implied ROE (pre-tax) 20.00% 15.00%

 Weighted
Distribution of a Average Capital
Loan Portfolio Charge

20% 1.2%
20% 1.2%
20% 2.4%
20% 2.4%
20% 2.4%
100% 9.6%

25%

20%

8%

Under Basel II
Increase Spread
7.40% <LIBOR+Loan Spread>

0.10%
0.50% <PD*LGD>

150%
12.00%
4.40% <(1-Capital ratio)*Debt funding cost>
 <Capital ratio*Risk weight*Target
2.40% ROE>

0.00%

<(Economic Return+Equity Capital

20.00% Charge)/Required Capital Ratio>