Currency swap debt is an $80 trillion global regulator, says 'blind spot'

Currency swap debt is an $80 trillion global regulator, says ‘blind spot’

LONDON, Dec 5 (Reuters) – Pension funds and other “non-bank” financial firms hold more than $80 trillion in hidden off-balance sheet dollar debt in foreign exchange swaps, the Bank for International Settlements (BIS) said. ).

The BIS, dubbed the central bank of central banks around the world, also said in its latest quarterly report that the 2022 market upheaval had largely passed without major issues.

After repeatedly urging central banks to act forcefully to dampen inflation, he adopted a more measured tone and weathered the problems in the crypto market and the turmoil in the UK bond market in September.

His main warning was about what he described as the “blind spot” of currency swap debt that risked leaving policymakers in the “fog”.

Foreign exchange swap markets, where for example a Dutch pension fund or a Japanese insurer borrows dollars and lends euros or yen before paying them back later, have a history of problems.

They experienced funding restrictions during the global financial crisis and again in March 2020 when the COVID-19 pandemic wreaked havoc which forced central banks such as the US Federal Reserve to step in with dollar swap lines .

The “hidden” debt estimate of more than $80 trillion exceeds stocks of dollar treasury bills, repo and commercial paper combined, the BIS said. It has fallen from just over $55 trillion a decade ago, while the turnover rate of currency swap deals was nearly $5 trillion a day in April, the two third of the world’s daily currency turnover.

For non-U.S. banks and non-U.S. “non-banks” such as pension funds, dollar obligations from currency swaps now represent double their dollar debt on the balance sheet, he estimated.

“The missing dollar debt from FX swaps/forwards and currency swaps is huge,” the Swiss-based institution said, adding that the lack of direct information on the scale and location of the problems was the problem. key.

Off-balance sheet and on-balance sheet dollar debt


The report also assessed broader recent market developments.

BIS officials have been loudly calling for aggressive interest rate hikes from central banks as inflation takes hold, but this time the tone has been more measured.

Asked if the end of the tightening cycle could be in sight next year, the head of the BIS’s monetary and economic department, Claudio Borio, said it would depend on how circumstances developed, also noting the complexity of the levels. high indebtedness and uncertainty about the current sensitivity of borrowers. are rising rates.

The crisis that erupted in UK gilt markets in September also underscored that central banks could be forced to step in and intervene – in the case of the UK by buying bonds even at a time when it was increasing interest rate to curb inflation.

“The simple answer is that we’re closer than we were at the start, but we don’t know how far central banks will have to go,” Borio said of interest rates.

“The enemy is an old enemy and he is known,” he added, referring to inflation. “But it’s been a long time since we fought this fight.”

Market volatility


The report also focused on the findings of the recent BIS Global Foreign Exchange Market Survey, which estimated that $2.2 trillion in currency trades are at risk of not being settled on any given day due to problems between counterparties, which could affect financial stability.

The amount at risk is approximately one-third of total currency deliverable revenue and is up from $1.9 trillion compared to three years earlier when the last currency survey was conducted.

Currency trading also continues to move away from multilateral trading platforms to “less visible” venues, preventing policymakers “from properly monitoring the currency markets”, he said.

The bank’s chief research officer and economic adviser, Hyun Song Shin, meanwhile, described recent problems in the crypto market, such as the collapse of the FTX exchange and stablecoins TerraUSD and Luna, as having characteristics similar to bank crashes.

He described many of the crypto coins being sold as “DINO – decentralized in name only” and that most of their related activities were done through traditional intermediaries.

“These are people who take deposits basically in unregulated banks,” Shin said, adding that much of it was about resolving large leverage and maturity mismatches, just like when of the financial crash more than ten years ago.

Reporting by Marc Jones; Editing by Toby Chopra and Alexander Smith

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