Morgan Stanley 2010 Annual Report Download - page 99

impacted by the developments concerning Basel III described below. Starting July 2010, the Company has been
reporting on a parallel basis under the current regulatory capital regime (Basel I) and Basel II. During the parallel
run period, the Company continues to be subject to Basel I but simultaneously calculates its risks under Basel II.
The Company reports the capital ratios under both of these standards to the regulators. There will be at least four
quarters of parallel reporting before the Company enters the three-year transitional period to implement Basel II
standards. Under provisions in the Dodd-Frank Act, the generally applicable capital standards, which are
currently based on Basel I standards, but may themselves change over time, would serve as a permanent floor to
minimum capital requirements calculated under the Basel II standards the Company is currently required to
implement, as well as future capital standards.
Basel III contains new capital standards that raise the quality of capital, strengthen counterparty credit risk capital
requirements and introduces a leverage ratio as a supplemental measure to the risk-based ratio. Basel III also
includes a new capital conservation buffer, which imposes a common equity requirement above the new
minimum that can be depleted under stress, subject to restrictions on capital distributions, and a new
countercyclical buffer, which regulators can activate during periods of excessive credit growth in their
jurisdiction. The Basel III proposals complement an earlier proposal for revisions to Market Risk Framework that
increases capital requirements for securitizations within the trading book. The U.S. regulators will require
implementation of Basel III subject to an extended phase-in period.
Under the Basel Committee’s proposed framework, based on a preliminary analysis of the guidelines published
to date, the Company estimates its RWAs at December 31, 2010 could increase by approximately $240 billion,
partially offset by a decrease of approximately $100 billion related to runoff and mitigation opportunities by the
end of 2012. The net increase in RWAs is estimated to be $140 billion, or approximately 43%, primarily driven
by higher market risk for securitization, structured credit and correlation products and credit risk for counterparty
exposures. These are preliminary estimates and they will likely change based on guidelines for implementation to
be issued by the Federal Reserve.
The proposed framework includes new standards to raise the quality of capital which may impact the components
of Tier 1 capital and Tier 1 common equity. The Company currently defines Tier 1 common equity as Tier 1
capital less qualifying perpetual preferred stock, qualifying restricted core capital elements (including junior
subordinated debt issued to trusts (“trust preferred securities”) and noncontrolling interest), adjusted for the
portion of goodwill and non-servicing intangible assets associated with MSSB’s noncontrolling interests (i.e.,
Citi’s share of MSSB’s goodwill and intangibles). This definition of Tier 1 common equity may evolve in the
future as regulatory rules may be implemented based on a final proposal regarding noncontrolling interest as
initially presented by the Basel Committee. For the discussion of Tier 1 common equity, please see “The Balance
Sheet” herein.
Pursuant to provisions of the Dodd-Frank Act, over time, the trust preferred securities will no longer qualify as
Tier 1 capital but will qualify only as Tier 2 capital. This change in regulatory capital treatment will be phased in
incrementally during a transition period that will start on January 1, 2013 and end on January 1, 2016. This
provision of the Dodd-Frank Act accelerates the phasing in of the disqualification of the trust preferred securities
as provided for by Basel III. At December 31, 2010, the Company had $4.7 billion of trust preferred securities
included in the qualifying restricted core capital elements. Effective March 31, 2011, the Federal Reserve will
institute a limit on restricted core capital elements that are included in Tier 1 capital. Amounts in excess of the
stated limit will be included in Tier 2 capital.
At December 31, 2010, the Company was in compliance with Basel I capital requirements with ratios of Tier 1
capital to RWAs of 16.1% and total capital to RWAs of 16.5% (6% and 10% being well-capitalized for
regulatory purposes, respectively). In addition, financial holding companies are also subject to a Tier 1 leverage
ratio as defined by the Federal Reserve. The Company calculated its Tier 1 leverage ratio as Tier 1 capital
divided by adjusted average total assets (which reflects adjustments for disallowed goodwill, certain intangible
assets, deferred tax assets and financial and non-financial equity investments). The adjusted average total assets
are derived using weekly balances for the year.
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