Correlations updated in a hurry

The disruption across capital markets over the last six months or so has forced a reassessment at Macquarie Group on the detail of some of its models and methods in what the bank is otherwise keen to portray as a rigorous risk control framework.

The penultimate slide in Macquarie's presentation yesterday notes that "few of Macquarie's stress tests have been exceeded.  However, we have revised our assessment of correlations between markets as it has become clear that previously
unconnected markets may move more closely together".

For Macquarie, and scores of financial institutions severely affected by the recent, and continuing, credit crunch, financial models are a bit like a lot of long-running climate models, with the infrastructure and investment strategy geared for a one in fifty year or one in 200 year flood. Yet suddenly there's a few one in a thousand year floods running past.

According to another slide Macquarie has "no material exposures not already known to investors; no problem trading exposures; no material problem credit exposures; no exposure to structured investment vehicles; no sub-prime lending; has a long standing policy of granting very few stand-bys and warehouses; no problems with debt underwritings and no underwriting of [highly] leveraged loans".

This was the kind of thing much more famous, and recently heavily loss-making, northern hemisphere banks would say in the third quarter of 2007. Presumably Macquarie is right about these things deep into the crunch.

The group also spelled out a few details on the implications of the Basel II regime for working out capital for regulatory purposes.

Macquarie said Basel II had a marginally negative impact on capital ratios and said  risk weighted assets would fall approximately 30 per cent. The changed treatment of market related contracts resulted in a reduction in off balance sheet risk weighted assets of around 10 per cent, but Macquarie said this benefit was largely offset by the increase in capital now required for equity risk, as well as the new capital requirements for operational risk and a net increase in tier one capital deductions.