Morgan Stanley 2014 Annual Report Download - page 112

minimum risk-based capital ratio requirements, new capital buffers, and certain deductions from and adjustments
to capital, will be phased in over several years. Prior to January 1, 2014, the Company and the Company’s U.S.
Subsidiary Banks calculated regulatory capital ratios using the U.S. banking regulators’ U.S. Basel I-based rules
(“U.S. Basel I”) as supplemented by rules that implemented the Basel Committee’s market risk capital
framework amendment, commonly referred to as “Basel 2.5.”
Regulatory Capital. Under U.S. Basel III, new items (including certain investments in the capital instruments
of unconsolidated financial institutions) are deducted from the respective tiers of regulatory capital, and certain
existing regulatory deductions and adjustments are modified or are no longer applicable. The majority of these
capital deductions are subject to a phase-in schedule and will be fully phased in by 2018. Unrealized gains and
losses on AFS securities are reflected in Common Equity Tier 1 capital, subject to a phase in schedule. The
percentage of the regulatory deductions and adjustments to Common Equity Tier 1 capital that applied to the
Company in 2014 ranged from 20% to 100%, depending on the specific item.
U.S. Basel III, which is aimed at increasing the quality and amount of regulatory capital, establishes Common
Equity Tier 1 capital as a new tier of capital, increases minimum required risk-based capital ratios, provides for
capital buffers above those minimum ratios, provides for new regulatory capital deductions and adjustments,
modifies methods for calculating RWAs—the denominator of risk-based capital ratios—by, among other things,
increasing counterparty credit risk capital requirements, and introduces a supplementary leverage ratio.
In addition, U.S. Basel III narrows the eligibility criteria for regulatory capital instruments. As a result of these
revisions, existing trust preferred securities will be fully phased-out of the Company’s Tier 1 capital by
January 1, 2016. Thereafter, existing trust preferred securities that do not satisfy U.S. Basel III’s eligibility
criteria for Tier 2 capital will be phased out of the Company’s regulatory capital by January 1, 2022.
Risk-Weighted Assets. The Company is required to calculate and hold capital against credit, market and
operational risk RWAs. RWAs reflect both on- and off-balance sheet risk of the Company. Credit risk RWAs
reflect capital charges attributable to the risk of loss arising from a borrower or counterparty failing to meet its
financial obligations. Market risk RWAs reflect capital charges attributable to the risk of loss resulting from
adverse changes in market prices and other factors. For a further discussion of the Company’s market and credit
risks, see “Quantitative and Qualitative Disclosures about Market Risk—Credit Risk” in Item 7A. Operational
risk RWAs reflect capital charges attributable to the risk of loss resulting from inadequate or failed processes,
people and systems or from external events (e.g., fraud, theft, legal and compliance risks or damage to physical
assets). The Company may incur operational risks across the full scope of its business activities, including
revenue-generating activities (e.g., sales and trading) and control groups (e.g., information technology and trade
processing). In addition, given the evolving regulatory and litigation environment across the financial services
industry and that operational risk RWAs incorporate the impact of such related matters, operational risk RWAs
have increased and may continue to do so.
The Basel Committee is in the process of considering revisions to various provisions of the Basel III framework
that, if adopted by the U.S. banking agencies, could result in substantial changes to U.S. Basel III. In particular,
the Basel Committee has finalized a new methodology for calculating counterparty credit risk exposures, the
standardized approach for measuring counterparty credit risk exposures (“SA-CCR”); has finalized a revised
framework establishing capital requirements for securitizations; and has proposed revisions to various regulatory
capital standards, including for trading and banking book exposures, the credit risk framework and capital floors.
In each case, the impact of these revised standards on the Company and the Company’s U.S. Subsidiary Banks is
uncertain and depends on future rulemakings by the U.S. banking agencies.
Calculation of Risk-Based Capital Ratios. On February 21, 2014, the Federal Reserve and the OCC approved
the Company’s and its U.S. Subsidiary Banks’ respective use of the U.S. Basel III advanced internal ratings-
based approach for determining credit risk capital requirements and advanced measurement approaches for
determining operational risk capital requirements to calculate and publicly disclose their risk-based capital ratios
beginning with the second quarter of 2014, subject to the “capital floor” discussed below (the “Advanced
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