Although the direct credit exposure of financial institutions to hedge funds seems to have been relatively modest, hedge funds’ activities, such as sudden large scale liquidation and the influence on market price dynamics and market liquidity, have posed an indirect risk to core financial institutions and the broader financial system.
Furthermore, the strong growth in the hedge fund sector has been one manifestation of the “shadow banking system” that has contributed to the overall high leverage and the vulnerability of the global financial system. Hedge funds are prone to price and liquidity shocks due to their usual combination of leveraged positions and short-term financing.