Two major European banks said they have exposure worth billions of dollars to a US broker accused of a $50bn (£33bn) Wall Street fraud scheme.
Spain's largest bank, Santander, which also owns three UK banks, said one of its funds had $3.1bn invested in the firm run by Bernard Madoff.
France's BNP Paribas estimated its exposure to be more than $460m.
Mr Madoff has been charged with fraud, in what is being described as one of the biggest-ever such cases.
Correspondents say the case is likely to fuel uncertainty about the entire hedge fund industry.
'Systemic failures'
Mr Madoff is alleged to have used money from new investors to pay off existing investors in the fund.
Investors are assessing their exposure to the alleged fraud Mr Madoff is said by prosecutors to have confessed to.
US Prosecutors say Mr Madoff, a former head of the Nasdaq stock market, masterminded a fraud of massive proportions through his hedge fund and investment advisory business.
"The collapse of Madoff is likely to accelerate the disappearance of hedge funds"
A federal judge has appointed a receiver to oversee Mr Madoff's firm's assets and customer accounts, while the 70-year-old banker has been released on $10m bail.
"While BNP Paribas has no investment of its own in the hedge funds managed by Bernard Madoff Investment Services, it does have risk exposure to these funds through its trading business and collateralised lending to funds of hedge funds," BNP said in a statement.
Santander said its exposure to Madoff was through its investment fund Optimal.
Santander also owns the UK High Street banks Abbey, Alliance & Leicester and Bradford & Bingley.
UK-based asset management firm Bramdean Alternatives accused US regulators of "systemic failures".
The firm saw its share value drop by over 35% after it revealed that about £21m - nearly 10% of its holding - was exposed to the New York broker.
"It is astonishing that this apparent fraud seems to have been continuing for so long, possibly for decades, while investors have continued to invest more money into the Madoff funds in good faith," the firm said.
"The allegations made appear to point to a systemic failure of the regulatory and securities markets regime in the US."
High returns promised
Mr Madoff founded Bernard L Madoff Investment Securities in 1960, but also ran a separate hedge fund business.
Investors have withdrawn from hedge funds amid market volatility.
According to the US Attorney's criminal complaint filed in court, Mr Madoff told at least three employees on Wednesday that the hedge fund business - which served up to 25 clients and had $17.1bn under management - was a fraud and had been insolvent for years, losing at least $50bn.
He said he was "finished", that he had "absolutely nothing" and that "it's all just one big lie", and that it was "basically, a giant Ponzi scheme", the complaint said.
He told them that he planned to surrender to the authorities but not before he used his last $200m-$300m to pay "selected employees, family and friends".
Under a Ponzi scheme, which is similar to pyramid schemes, investors are promised very high returns on their investment, while in reality early investors are paid with money collected from later investors.
If found guilty, US prosecutors say he could face up to 20 years in prison and a fine of up to $5m.
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