Non-bank financial institutions: assessment of their impact on the stability of the financial system

€
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Debt
Equity

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9 
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Hedge fund sector risks 
 
 
 
 
 
 
 
 
83 
 
9
 
Hedge fund sector risks 
9.1
 
Overview 
The impact of hedge funds on financial stability during the financial crisis appears to be a story of 
the relationship between banks and hedge funds. The underlying causes for the build-up of risks 
centres around excessive risk-taking by hedge funds, due to prime broker, trading or ownership 
relationships with banks.
Table 17: Overview of risks to financial stability related to hedge funds 
 
 
U
nde
rly
ing
ca
us
es
Excessive risk-taking 
due to: 

Procyclical margin requirements by prime brokers, implying leverage and therefore 
liquidity risk

Market power of large hedge funds vis-à-vis prime brokers, implying leverage and 
therefore liquidity risk

Bank ownership of hedge funds
Concentration of holdings among few counterparties, especially banks 
Mul
tipl
ie
rs
Size of funds 
Inter-connectedness of funds
,
 
particularly to banks through prime brokerage or as major trading 
counterparties
 
 
Pr
ox
im
at
e 
ca
us
es
Events around the financial crisis bringing about the materialisation of liquidity risk (e.g., asset 
devaluations)