ECB warns of hedge fund risk to European banks

The European Central Bank (ECB) has warned that European banks could be vulnerable to credit market volatility through their growing exposure to hedge funds.

The ECB said the biggest challenge for banks was to monitor the risk involved in a sudden liquidation of leveraged positions by hedge funds.

While in general hedge fund risks were "contained", the bank said, leverage increased the risk for banks, as did "crowding" of hedge fund trades.Overall, the report said, while the last year had been a good one, the system's ability to deal with a crisis was uncertain. "The present, positive conditions may not easily carry over into the medium or long-term, as they are dependent on currently very benign liquidity and credit conditions," the bank said, adding that growing competition could have led to relaxed credit standards, leaving many banks without sufficient cushioning against a drop in credit quality.