Banks' Interactions with Highly Leveraged Institutions

Executive summary

This report serves three primary objectives:

• Evaluating the potential risks resulting from the activities of HLIs, with particular regard to their interactions with banks.
• Assessing the deficiencies in banks' risk management practices in respect of HLIs.
• Evaluating alternative policy responses for addressing these risks, including the encouragement of sound practice on the part of banks.

While it is virtually impossible to provide a precise definition of an HLI, for the purpose of this paper the focus will be on large financial institutions that have the following characteristics: (a) they are subject to little or no direct regulatory oversight, as a significant proportion operate through offshore financial centres; (b) they are subject to limited disclosure requirements; and (c) they take on significant leverage. The Committee recognises that not all so-called hedge funds have these characteristics while many mainstream financial institutions exhibit some of them. As such, the recommendations of the report refer to banks' dealings with institutions that pose the particular counterparty risks arising from such characteristics, however they may be classified.