FX swap debt is a "blind spot" worth $80 trillion

A 'blind spot' of $80 trillion in debt is associated with currency swaps.

The Bank for International Settlements (BIS) said that pension funds and other "non-bank" financial firms have more than $80 trillion in dollar debt that is not shown on their balance sheets. This debt is in FX swaps.

The BIS, which is known as the central bank of the world's central banks, also said in its most recent quarterly report that the market turmoil of 2022 had been mostly handled without any major problems.

After repeatedly telling central banks to take strong action to stop inflation, it took a calmer tone and talked about problems in the crypto market and the UK bond market in September.

Its main warning was about the "blind spot" of FX swap debt, which it said could leave policymakers in a "fog."

FX swap markets, in which, for example, a Dutch pension fund or a Japanese insurance company borrows dollars and lends euros or yen before paying them back, have a long history of problems.

During the global financial crisis and again in March 2020, when the COVID-19 pandemic caused chaos that forced central banks like the U.S. Federal Reserve to step in with dollar swap lines, they had trouble getting enough money.

The BIS said that the estimated "hidden" debt of $80 trillion or more is more than the stock of dollar Treasury bills, repo, and commercial paper put together. Ten years ago, it was just over $55 trillion. In April, FX swap deals were worth almost $5 trillion a day, which was two-thirds of the daily global FX turnover.

It was estimated that the dollar obligations from FX swaps for both non-U.S. banks and non-U.S. "non-banks" like pension funds are now double their on-balance-sheet dollar debt.

"The missing dollar debt from FX swaps, forwards, and currency swaps is huge," the Switzerland-based institution said, adding that the lack of direct information about the size and location of the problems was the biggest problem.

The report also looked at trends in the market as a whole.

As inflation has gotten worse, BIS officials have been loudly calling for central banks to raise interest rates in a strong way. This time, however, they used a more calm tone.

When asked if the end of the tightening cycle might be coming up next year, Claudio Borio, head of the BIS's Monetary and Economic Department, said it would depend on how things change. He also pointed out that the situation is complicated by high levels of debt and the fact that it's not clear how sensitive borrowers are to rising rates right now.

The crisis in the UK gilt markets in September also showed that central banks could be forced to step in and help. In the UK's case, the central bank was forced to buy bonds even though it was raising interest rates to stop inflation.

The report also focused on the results of a recent BIS global FX market survey, which found that $2.2 trillion worth of currency trades could fail to settle on any given day because of problems between counterparties. This could threaten the stability of the financial system.

When the last FX survey was done three years ago, the amount at risk was $1.9 trillion, which is about a third of the total amount of deliverable FX turnover.

It also said that FX trading is still moving away from multilateral trading platforms and toward "less visible" venues, which makes it harder for policymakers to "properly monitor FX markets."

Hyun Song Shin, the bank's Head of Research and Economic Adviser, said that recent problems in the crypto market, like the collapse of the FTX exchange and the stable coins TerraUSD and Luna, were like bank crashes.

He said that many of the crypto coins that were being sold were "DINO," or "decentralised in name only," and that most of the things that happened with them went through traditional middlemen.

Shin said, "This is basically people putting money into banks that aren't regulated." He added that it was mostly about large leverage and maturity mismatches coming apart, just like during the economic collapse more than a decade ago.