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Hedge Fund Exposure Not a Danger to EU Banks

The European Central Bank noted the potentially dangerous areas of large EU banks' exposure to hedge funds in a new report. In general, the financial stability of EU banks is not at risk based on its exposure to hedge funds.

The study was conducted by the Banking Supervision Committee (BSC) of the European System of Central Banks. It is part of the BSC's continued efforts to obtain a complete understanding of the implications of rapid hedge fund activities on the European financial structure. The report examines the strength and significance of the links that have developed between large EU banks and hedge funds.

Overall, the report concluded that recent developments in the hedge fund industry likely do not pose a direct threat to the financial stability of the EU. The scope of EU banks' direct exposure to hedge funds varied considerably across countries, and most banks dealing extensively with hedge funds held specific guidelines and advanced risk management systems for this area of business.

However, several areas were highlighted for improvement in the report. These included banks' stress tests, which proved insufficient, the aggregation by banks of hedge fund exposures across the entire financial group, business area or geographical region, and the disclosure of information by hedge funds to investors.

These difficulties limit the transparency of hedge fund activities and make exhaustive analysis of hedge fund exposure risk by EU banks a particularly complex, and somewhat inconclusive, endeavor.

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