LONDON (Reuters) - Global financial regulators worry that banks are scaling back costly market making functions and that this could leave investors stranded, as well as squeezing funds to drive economic recovery, a senior official said on Tuesday.

Some banks have already warned that tougher rules designed to make the financial system safer since the crisis of 2008-2009 have pushed up the cost of market making, or providing facilities for investors to buy and sell shares, bonds and derivatives.

David Wright, secretary general of the International Organization of Securities Commissions (IOSCO), which groups market regulators like the U.S. Securities and Exchange Commission and Germany’s Bafin, said it was an issue that was being looked at.

“It’s a concern. I think this is at the research stage,” Wright told Reuters on the sidelines of a conference, the fear being that thinner liquidity will lead to markets freezing up when they come under stress, leaving investors with nowhere to go.

“We have seen a ‘Houdini’ disappearance of market makers in general,” Wright added. “First of all we have got to establish the facts, look at the markets ... and see if this is a big problem ... It’s a new frontier-type issue. I think it’s partly caused by some regulation, but we need to know.”

Researchers at the Financial Stability Board (FSB), which coordinates regulation in the Group of 20 countries (G20), have already raised the issue, Wright noted.

Richard Semark, a senior executive at UBS UBSN.VX who deals with European client trading requirements, told Reuters that shrinking liquidity is an issue in Europe's fixed income market, because new rules make it more expensive for banks to hold the inventory of bonds needed for market making.

New European Union rules will also effectively ban off-exchange trading of shares among banks and big investors, Semark said. “It seems as though in Europe that almost from every angle liquidity is being squeezed.”

Banks have also warned that market making could take a further dent if the EU goes ahead with a measure to isolate risky trading at banks. However the European Central Bank has already acknowledged bank structural reform measures need tweaking to avoid harming market making.