Banks’ increasing exposure to hedge funds and proprietary trading firms has raised concerns about financial market stability, according to a recent report from a major ratings agency. The surge in financing extended by a small group of global investment banks to these firms, combined with historically high leverage levels, has created what officials described as an “inherent fragility” within the financial ecosystem.
The analysis highlights a significant shift in market dynamics driven by firms such as Jane Street, Hudson River Trading, Citadel Securities, and others, which have expanded rapidly in recent years. Their growth has been largely fueled by lending from traditional investment banks that have reduced their own proprietary trading activities. This transformation has led banks to rely more heavily on prime brokerage and market financing services, providing funding and infrastructure to these non-bank trading firms rather than engaging in direct trading.
Prime brokerage borrowing, a broad category encompassing various financing and post-trade services to hedge funds and trading firms, surpassed $2.5 trillion in 2024—doubling over the past four years. This segment has become a major revenue driver for banks, compensating for slower activity in other areas such as dealmaking. For instance, four large investment banks—Goldman Sachs, Morgan Stanley, Barclays, and BNP Paribas—generated combined revenues of approximately $25 billion from market financing activities in 2025, marking a 25% increase from the prior year. Goldman Sachs alone reported that nearly half of its first-quarter equities trading revenue in 2026 came from financing, with significant additional income from fixed-income financing.
The report stresses that while such financing arrangements can be lucrative, they entail risks that could affect the broader financial system. Short-term loans used to support trading positions may evolve into longer-term liabilities that absorb bank capital and put downward pressure on credit ratings. Market financing can reduce liquidity in the short term, and the concentration of exposures among a handful of banks increases vulnerability to stress events. Moreover, if a leveraged trade fails, it could trigger forced asset sales and contagion effects.
Leverage within hedge funds reached record highs, according to data from the U.S. Federal Reserve, and the overall assets managed by these firms hit estimated all-time highs near $5 trillion last year. This has prompted regulators and financial watchdogs—including the Financial Stability Board and the Bank of England—to increase scrutiny of the links between banks and non-bank trading entities. Concerns are especially focused on risks posed by leveraged bets in critical markets, such as U.S. and U.K. government bonds.
Past incidents like the 2021 collapse of Archegos Capital Management, which caused billions in losses at several banks and contributed to the downfall of Credit Suisse, have heightened awareness of the systemic risks posed by concentrated exposures to non-bank trading firms. However, the ratings agency noted that such large-scale failures are infrequent, and, to date, banks have generally maintained sound risk management practices related to funding, liquidity, capital, and earnings.
The report also points to competition among banks, which can lead to reduced margin requirements and haircuts in the financing business, potentially exacerbating risks. Proprietary trading firms and hedge funds remain poised for further growth, raising concerns about greater concentrations of risk and the challenge of accurately measuring the full scale of exposures, given limited public disclosure from many of these entities.
Overall, the findings underscore the need for continued monitoring of the evolving relationship between traditional banks and the rapidly expanding universe of hedge funds and proprietary trading firms, as their interconnectedness and leverage could pose challenges during periods of market stress.