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You are the Treasurer of a company that has recently been upgraded from A to AA. You have approached your relationship bank to see if they are prepared to reduce the margin they charge on your £100m loan facility which is fully drawn. In the past, the bank has insisted any loans it makes must meet its required return on capital targets independent of other fee-based business it may receive. The bank's capital ratios are close to the regulatory minimum.
You are aware the Basel II (‘Pillar One') proposals on bank capital adequacy mandate a 50% risk weighting for A-rated borrowers and a 20% risk weighting for AA-rated borrowers.
Assuming these proposals are implemented, use the information below to determine how much the bank could afford to reduce its spread (while maintaining its required returns on regulatory capital) as a result of your upgrade?
Your bank's capital adequacy 8% (i.e. capital / risk assets) Your bank's required return on capital 10% post-tax (including all Tiers of capital) Corporate tax rate 30%
