Regulatory capital requirement
Since the financial crisis of 2009, there has been intense pressure on US banks to raise capital levels to meet minimum requirements. Since then, banks have worked hard to reduce leverage and fortify their balance sheets. Morgan Stanley (MS) has made strengthening its capital position a priority during its turnaround because a lack of sufficient capital is what caused the bank to nearly go out of business during the crisis. The Federal Reserve mandates higher levels of capital for this very reason.
Leverage ratios are measures of the quality of banks’ assets. Beginning on January 1, 2018, the company must maintain a Tier 1 supplementary leverage capital buffer of at least 2% in addition to the 3% minimum supplementary leverage ratio (for a total of at least 5%), in order to avoid limitations on capital distributions and discretionary bonus payments to executive officers. Tier I capital is a measure of a bank’s financial strength from a regulator’s point of view. In 2Q16, Morgan Stanley’s Common Equity Tier 1 capital ratio was 16.9% while its Tier 1 risk-based capital ratio was 18.8%. Meanwhile, its leverage ratio improved to 6.1% during the quarter. This makes the bank’s assets less vulnerable to global downturns.
Investors seeking exposure to a portfolio of these banks could invest in the Financial Select Sector SPDR ETF (XLF) or the Vanguard Financial ETF (VFH). Banks constitute ~50% of these ETFs. Banks like JP Morgan (JPM), Morgan Stanley (WFC), and Bank of America (BAC) are well represented in these portfolios.