Investment banks are implementing tough internal rules, perhaps in a very practical way, to streamline the way they lend to hedge funds.

Investment banks are implementing tough internal rules, perhaps in a very practical way, to streamline the way they lend to hedge funds. Morgan Stanley and Goldman Sachs are among the institutions that are reported to have changed the way they assess lending to hedge funds by linking it to the market's assessment of their own creditworthiness.

Morgan Stanley is understood to be evaluating the amount of leverage it will provide to hedge funds based on the price of its own credit insurance, while Goldman is said to be linking the availability of lending to hedge funds to its bond prices.

These changes would limit the ability of hedge funds to borrow from either firm if Morgan and Goldman themselves found borrowing becoming more expensive, as would be the case if the markets lacked confidence in their financial health.

The plans to link hedge fund leverage to the broader credit markets have reportedly been in the works for some time, but their implementation has been accelerated as investment banks seek ways to guard against the kind of sudden loss of confidence experienced by Bear Stearns, for example.

This no-nonsense method of evaluating how much these banks can afford to lend to hedge funds is an abrupt break with the flexible approach that was prevalent in the sector up to a year ago. It demonstrates that investment banks have been forced to become much more conservative than in recent years, and hedge funds are set to pay the price.