The largest hedge funds typically have assets under management of less than $ the largest banks assets in excess of $ trillion. Unlike banking, concentration in the hedge fund sector is low and has been falling. The top 5 hedge funds comprise around 8% of total assets, down from 30% a decade ago (Chart 10). Unlike banking, the business models of hedge funds are typically specialised rather than diversified. And unlike banking, entry and exit rates from the hedge fund industry are both high. The annual average attrition rate for hedge funds is around 5%. At present, it is around double that. Among US banks, the average attrition rate over the past few decades has been less than 0.1%; it has not come close to hitting 5% at any point since the Great Depression. It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of “highly-leveraged institutions”, most hedge funds today operate with leverage less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system. 18  King (2009), Dudley (2009). 19  King (2009). 20  For example, Kay (2009), G30 (2009).
BIS Review 139/2009  9  (b)  Redesigning the safety net  •  A framework for the banking safety net: Even with systemic risk reduced, the state is unlikely to be able credibly to stand aside when future tail risks eventuate, as they are sure to do. Some bulwark is needed. As in other public policy arena, a predefined and transparent regime can help reinforce the credibility of ex-post actions, serving as a pre-commitment device. At present, only some of the ingredients of such an ex-ante framework exist. Internationally, deposit insurance frameworks tend to be fairly well-defined; liquidity insurance frameworks somewhat less so. Both are much better defined than frameworks for capital insurance. A well-articulated framework for the banking safety net would not only provide greater clarity on each of these pieces. It would also set out interactions and interdependencies between them – when and how the different insurance strands come together to avert crisis. At present, no such ex-ante map exists. Having one in future would not guarantee, but could only increase, the chances of it being adhered to. •  Time-consistent liquidity insurance: Almost all central banks have flexed their liquidity frameworks during the course of this crisis. And rightly so. In many cases, this has meant a combination of longer-maturity lending to a broader range of financial institutions against a wider set of collateral. Pre-crisis liquidity insurance frameworks were shown during crisis to lack time-consistency. How can we best guard against a recurrence? Two elements are key.