Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Break-even loan pricing and the ‘equity’ spread

Let us consider a loan of 100 that has a maturity of one year. The loan is funded partly on the interbank market and 8% capital.

Here is the funding structure:

Funding
Loan	100	Interbank deposit	92
		Equity	8

To keep the example simple, we have used 8% of equity even if the BIS definition of capital allowed us to use less equity (Tier 1) and more subordinated debt (Tier 2). Note also that the relevant debt is the interbank debt, not the deposits collected from customers. Indeed, according to Stage 5, we want to take into account the incremental impact of a loan on the interbank position of e-Bank.

The interbank rate is 10%, e-Bank pays a corporate tax rate of 40%, and the shareholders of e-Bank demand ...