Capital management

The approach we take to capital management is one of our hallmarks. We endeavor to maintain strong debt ratings and sound capital ratios (see capital strength box below), to reinforce our position as one of the best-capitalized financial services firms in the world. Being strongly capitalized allows us to invest in the growth of our businesses – whether organically or by acquisition. If we do not see opportunities to invest in growth, we return capital to our shareholders.

In managing our capital, we look at both required capital (the minimum amount of capital required to underpin our risks according to regulatory requirements) and our available eligible capital (our capital measured according to the regulators' criteria) and forecast their future development. Dividend payments and share buyback programs are the main tools by which we manage our capital base. That, along with the capital securities we issue, gives us the means to manage our capital ratios, helping us protect our strong capitalization and credit ratings while ensuring we continue to create sustainable value for shareholders.

Capital requirement

The capital we are required, by banking regulation, to hold is determined by our risk-weighted assets – our balance sheet, off-balance sheet and market risk positions, measured and risk-weighted according to criteria defined by our lead regulator, the Swiss Federal Banking Commission (SFBC). For instance, credit exposures to third parties are measured according to the type of instrument (and collateral, if any) and risk-weighted according to the type of counterparty. Market risk positions are generally measured using a Value at Risk (VaR) model. For more detail on these calculations please refer to note 29 to the financial statements. Most of our capital requirement arises from balance sheet assets. Off-balance sheet positions contributed 14% and market risk positions 6% of total risk-weighted assets and, correspondingly, of our total capital requirement on 31 December 2006.

The capital available to support these risks – eligible capital – consists of two elements – Tier 1 capital which is primarily shareholders' equity with certain adjustments defined by regulation, and Tier 2 capital which consists of long-term subordinated debt. Tier 1 capital is required to be at least 4% and total capital (Tier 1 plus Tier 2)at least 8% of risk-weighted assets.

Our published risk-weighted assets and capital ratios are determined according to the Basel Capital Accord (BIS guidelines). The calculation of UBS's capital requirement under the regulations of the SFBC differs in certain respects from the calculation under BIS guidelines. The most important differences are:

– where BIS guidelines apply a maximum risk weight of 100%, the SFBC applies risk weights above 100% to certain asset classes (for example real estate, fixed assets, intangibles, and non-trading equity positions)

– where the BIS guidelines apply a 20% risk weight to obligations of OECD banks, the SFBC applies risk weights of 25% to 75%, depending on maturity.

As a result of the differences in regulatory rules, UBS's risk-weighted assets are higher, and our capital ratios (total and Tier 1), are lower, when calculated under SFBC regulations than under BIS guidelines. UBS has always had total capital and Tier 1 capital well in excess of the minimum requirements of both the BIS and the SFBC.

Capital ratios

On 31 December 2006, risk-weighted assets were CHF 341.9 billion, up 10% from CHF 310.4 billion a year earlier. Roughly 75% of the increase was driven by our Investment Bank activities (including acquisitions in 2006) and the remainder was contributed by our lending business in Global Wealth Management & Business Banking. On 31 December 2006, BIS Tier 1 capital was CHF 40.5 billion, up from CHF 39.8 billion a year earlier, reflecting a strong operational profit in 2006, partially offset by various acquisitions in 2006, negative currency fluctuations and higher dividend accruals. The combination of the 10% risk-weighted assets increase and the 2% growth in BIS Tier 1 capital resulted in a decrease of our BIS Tier 1 ratio by 0.9 percentage point to 11.9% at the end of 2006 from 12.8% on 31 December 2005. Our total BIS ratio at 31 December 2006 was 14.7%, up from 14.1% a year earlier, due to the issuance of additional lower Tier 2 capital (subordinated debt) in 2006.

For details of UBS's issuance of capital securities during 2006, including preferred shares and subordinated debt, please see the Capital Structure section of the Corporate Governance chapter.

Introduction of Basel II

Upon implementation of Basel II on 1 January 2008, we ­expect the overall impact on our BIS Tier 1 ratio to be slightly negative, depending on the further development of our business mix, in particular the profile of our loan book. This expectation is based on a direct comparison between our capital requirements under current regulations at 31 December 2006, and the corresponding requirements for the same date but using the Basel II rules, generated using the IT systems and processes we plan to use when Basel II comes into effect.