If the Bank of International Settlements is trying to minimise the shock of its new set of capital accords, it is managing the job perfectly. Outside of various corners of the specialised lending business it is difficult to find many ripples of excitement about the new lending accords. The timetable has slipped so frequently for the new proposals that national regulators are likely to take a relaxed view of implementation as and when a final draft appears.

This softly-softly approach has benefited project lenders, which were, under the first set of proposals, set to be put out of business. The proposals would likely have meant that banks would have to set aside so much regulatory capital against project finance debt that it would have become difficult to turn a profit on the product. The prospect managed to stir banks into the unusual step of creating a united front to lobby the BIS.

After meetings in New York and London (for full details, search 'Basel' on www.projectfinancemagazine.com), banks came together to commission a study of their portfolios to determine how risky project debt can be. The original four - ABN Amro, SG, Deutsche Bank, and Citigroup - featured one bank that had managed to securitize its loan portfolio (Citi), and two that were attempting to (SG and Deutsche).

Much of the portfolio would already be under the microscope of the ratings agencies while they assessed how to rate prospective collateralised loan obligations. Nevertheless, Standard & Poor's now receives an annual fee to look over a loan portfolio that covers 25 banks and a substantial majority of outstanding project debt. The study now has over 2300 loans going back to 1988.

The study bore out what Chris Beale, Citi's global project and structured finance head, said in December 2001 - that project finance's default and recovery rates were better than they were for corporate debt. This evidence has been very convincing in front of the BIS - so much so that banks are now confident that project lending will now be economical.

The original proposals called for an across-the-board risk weighting of 150% on project finance loans. The committee acknowledged that there was little in the way of data, and too much of an interaction between default events and recovery rates, to assume that banks would be able to accomplish risk weighting procedures properly.

The initial reaction to the proposals now looks a little alarmist - the regime was 'punitive' as one banker put it, but the committee showed itself prepared to overcome its lack of familiarity with project lending and solicit relevant data from lenders. Standard & Poor's, which had been deeply involved with the portfolios of banks looking to issue project CLOs, was commissioned to collect the data.

S&P looked like just the independent, disinterested agency most suited to hold data that banks feel is proprietary. This looked like the nearest that the banks would come to creating a united front, and institutions have come in - now 25 banks are involved - to represent a majority of outstanding project debt. But the services of S&P's RiskSolutions group, the specially-formed, operationally separate consulting arm, do not come cheap.

So what does your $50,000 annual fee to S&P get you? The initial pitch was that the fee was a small price to pay to keep project lending viable. The data gained by the group proved useful in presentations to the Basel committee during the middle of 2003. It has managed to remove the onerous weighting of the standardised approach, and integrate a less burdensome and more nuanced set of weightings into its other two approaches.

The initial set of guidelines would have established a standardised and an internal ratings-based approach. The standardised approach still has fairly brutal 'slottings' as the accord calls them. Banks have to set aside 75% of debt rated A- or higher, 100% for BBB- or higher,150% for BB, 350% for B- or higher, and 650% for C-rated debt. Unrated debt carries a 100% rating, so that debt unlikely to gain an investment grade will not likely trouble the agencies. Banks that carry out an internal rating will not be under any obligation to share this.

The advanced approach has been split into the foundation and advanced streams. The difference between the two, as far as project lenders are concerned, is that in the advanced stream, banks are assumed to have sufficient data to create robust probability of default (PD) and loss-given-default (LGD) assumptions. In the foundation stream, banks might have sufficient PD data, but lack the LGD data to set their own risk weightings, which will likely be set by regulators.

Basel II's latest project finance weightings

Rating (or higher) Standard Foundation

A- 75 35

BBB- 75 55

BB- 100 150

B- 350 186

C 650 188

Source: Citibank

The table above shows that sufficient data will give banks a clear competitive advantage in project lending, but that this is likely to be beyond the resources of a single institution. As such, and this is certainly a hope expressed by Beale, banks will likely need to be a part of the study to gain the more generous treatment.

However, the old argument against pooling resources, that the data is proprietary, looks likely to make adoption of the study into an exclusive, and expensive club. For the price of a junior banking associate, lenders will be able to compete with the biggest players in project debt. And if they cannot satisfy national regulators that they can follow in the internal ratings based approach, the gap between the smaller banks and the bigger players will grow. Nevertheless, an official at a (rival) ratings agency says that it will be difficult to enshrine this private study into the regulations. "If they don't want the syndications market to shrivel, then I don't see how they can avoid sharing the data," he says.

Some national regulators have already imposed this gap - the US Federal Reserve looks set to allow only five or six institutions to follow the internal ratings-based approach. Since US banks, with the exception of Citi, have long since lost interest in long-dated project lending, the effect on the market there will be minimal.

What is more intriguing is the possible effect upon long-dated lending in Europe. Those backing the new proposals, including, unsurprisingly, Citi, say that they are designed to reward those with the strongest risk management practices without penalising project finance per se. They may, however, lead to the exit of the European mortgage and savings banks from the long-term lending business, and the end of a viable alternative to the bond market.

Evidence from Spain, for instance, suggests that the small Cajas, which have proved vital in the financing of the country's transport infrastructure, may become more averse to long-dated deals. Sponsors looking to get transport assets financed may have to turn to the immature and shallow bond market. Banks may largely, if at all, be confined to taking on short-term construction risk.

This would mirror the practice in the US since the early days of the power finance - the separation of the bank finance market for construction from the bond market for long-term take-out. But the US has a larger and more sophisticated group of insurance and pension companies. While banks do not at present make up a large proportion of the buyers of euro bonds, they do buy into some infrastructure deals, and may have to take further steps to develop market depth.

The picture is made even less clear by the convulsions hitting the German landesbanks, which will be losing their guarantees imminently. This factor has already caused panic at some German lenders - a leaked report has suggested that WestLB's rating will be in the low BBB range once it loses its state guarantee. Some have argued that the landesbanks might go hunting for high-yielding assets such as LBO and project loans, to make up the returns that used to be provided by exploiting a low cost of funding. But the initial shock, as well as poor prospective ratings, may drive the German lenders into areas perceived as lower-risk or less labour-intensive than project finance.

The Basel accords may, however, stimulate a secondary market in project debt, since the CLO concept has fizzled out. The CLO is, notes one of its practitioners "a rather elegant solution to holding project debt, since it allows you to maintain involvement in deals. But it has been difficult to structure the first loss piece." Bulk sales of debt to a trade buyer can send out a different message, as those involved are often accused - occasionally falsely - of wanting to exit the business.

Nevertheless, HVB Group has been able to structure a partnership for project loans where it is a general partner in a partnership buying them, and GE Capital fronts the bulk of the money to buy them. It means that HVB has a role in managing the portfolio, but improves its tier one capital position. Sources at HVB say that the move was more driven by the bank's need to clean up its portfolio than Basel concerns: "it is part of our process of improving our rating." Another banker notes that Basel will probably affect the way banks do business, and has seen some pressure on pricing upwards, with the exception of UK PFI.

Indeed in the Middle East, some banks are secretly hoping that the accord might force up pricing, which has become incredibly keen thanks to the depth of liquidity at regional lenders. But, as Chris Vermont, ANZ's newly-promoted head of debt solutions, says, "there is little sign in the near-term that regional regulators are going to impose stringent weighting requirements on the regionals."

ANZ produced its own presentation for the committee, and voiced a familiar complaint - that Basel is not generous enough to the strongest credits. The new regime looks set to be fairer, and also to give more credit to enhancements such as preferred credit status. This is good news for the International Finance Corporation (IFC), which had been concerned that the B loan programme, where the IFC syndicates down to banks the benefits of the status, would be killed off.

Nevertheless, the accords will on balance probably lead to an increase in business for the agencies, even if they are unable to charge every market participant to handle their data. They will probably increase the transparency of project finance loans, if deals need to be syndicated widely, and be more tightly structured.

However, the study is not a static, final picture. As Michael Wilkins, managing director in charge of infrastructure finance at S&P in London notes, "the study is a retrospective one, and reflects the situation to the end of 2002". And 2003 has been a year dominated by workouts and restructurings. The 45% LGD number, criticised by Fitch and others, may turn out to be close to the real figure, once bankers in the US and UK complete their provisioning against power exposures.

But the study does have the potential to reshape bank behaviour, in that its incomparable resource of data is ripe for further mining. Banks will be able to more accurately describe the relationship between, say, pricing and default levels. They can also take a more long-term view as to which parts of the business provide the bet yields. Sponsors can still be confident that the product will exist, but should prepare for a difference in the way it is provided.