CFO.com – Banks should impose stricter lending standards on hedge funds, the president of the Federal Reserve Bank of New York said Tuesday. That is the strongest suggestion yet that bank regulatorsremain concerned about often incestuous relationships that allow banks to lay off risk to hedge funds, even as those funds borrow from banks to fund their activities.
Speaking at the Third Credit Risk conference at the NYU Stern School of Business, New York Fed president Timothy Geithner echoed former Federal Reserve Chairman Alan Greenspan in nothing “The transfer of credit risk from banks to non banks “probably improves the overall efficiency and resiliency of the system.” Unlike Greenspan, however, Geithner stressed the word “probably.”
Geithner went on to note that bank regulators have “some concern and unease” based in part on uncertainty. “There’s a lot we do not know” about non-bank market participants, he said, referring to largely unregulated hedge funds. He then offered several suggestions, noting that his overall objective was to encourage “greater caution and conservativism” on the part of the banks.
Bank relationships with hedge funds have been the subject of recent industry efforts at self-regulation, notably the 273-page report of the Counterparty Risk Management Policy Group II. Produced by Gerald Corrigan, a former Federal Reserve official who conducted a bank-sponsored postmortem on Long Term Capital Management, the report painted a rosy picture of improvements in the financial world’s handle on market and credit risk, but warned that operational risks resulting from the rapid rise in the use of credit derivatives and other financial innovations could, under the wrong circumstances, spiral out of control.
