Can a Bank Invest in a Hedge Fund?

by Will Gish

Banks commonly invest money as a means of generating capital and expanding operational capabilities. Myriad investment opportunities exist for banks, including hedge funds. Hedge funds sell shares for large sums of money and invest vast amounts of capital in a variety of markets. Determining whether a bank can invest in a hedge fund requires an examination of bank investment practices and the relationships between hedge funds and the different types of banks.

Retail and Commercial Banks

Retail banks constitute the banks you deal with on a day-to-day basis. These banks maintain branches throughout regions or countries and offer standard services such as checking accounts, savings accounts, loans and mortgages. Commercial banks maintain multiple operations, including consumer retail banks, business banking and investment opportunities. Traditionally, these banks may invest in securities such as hedge funds if they possess enough capital for such large investments. In 2010, Sen. Chris Dodd of Connecticut introduced legislation designed to rectify many of the problems associated with the financial crisis of 2008-2009. This bill contained provisions preventing retail banks from investing in hedge funds, but it was never passed into law.

Private Banks

The answer to whether a private bank can invest in a hedge fund is yes. Private banks constitute those banks not publicly traded and only open to certain clients. These banks bear some similarities to retail banks, but they only accept customers with vast income and assets. Private banks commonly invest in hedge funds as a means of generating capital and increasing the wealth of clients. Writing for world news service Reuters, author Kevin Lim asserted in 2010 that private banks in Asia favor event-driven hedge funds as their primary investment source.

Investment Banks

Investment banks maintain a complex relationship with hedge funds. In the simplest terms, investment banks can and do invest in hedge funds regularly. Many large investment banks run their own hedge funds, which they create with large investments. In other instances, investment banks help fund managers create hedge funds by investing capital at the outset of investing. These banks also invest in hedge funds through a technique known as "fund of funds," which occurs when one fund invests in another. For instance, an investment uses its own hedge fund to invest in another hedge fund.

Shadow Banking

Shadow banking constitutes a market that exists “in the shadows” of the standard banking and trading markets. Basically, this market comprises the direct exchange of funds between banks, hedge funds, pension funds, endowments and other financial entities. Through shadow banking, private banks, investment banks and large retail banks invest capital in hedge funds and vice versa. Financial analyst Alain Sherter writes that the shadow market is positive in that it allows financial entities to use their strengths for collective benefit, though too much interconnectivity in this market may lead to a calamitous mass collapse.

About the Author

Will Gish slipped into itinerancy and writing in 2005. His work can be found on various websites. He is the primary entertainment writer for "College Gentleman" magazine and contributes content to various other music and film websites. Gish has a Bachelor of Arts in art history from University of Massachusetts, Amherst.

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