FX debt replaced by $80 trillion ‘blind spot’, says global regulator

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

The BIS, which named the central bank among the world’s central banks, also said in its latest quarterly report that the market’s turnaround in 2022 was managed without major problems.

He struck a more measured tone, repeatedly urging central banks to act strongly to reduce inflation, and singled out crypto market woes and the turmoil in the UK bond market in September.

His main warning was about what he described as a “blind spot” of FX swap debt, which risks leaving policymakers in a “fog”.

For example, there are problems in currency exchange markets, where a Dutch pension fund or a Japanese insurer borrows dollars and then lends out euros or yen before paying them back.

They saw financial distress both during the global financial crisis and in March 2020 when the COVID-19 pandemic caused a catastrophe that required central banks like the US Federal Reserve to intervene in dollar exchange lines.

According to the BIS, the estimated $80 trillion in “hidden” debt exceeds holdings of dollar Treasury bills, repos and commercial paper. That’s up from just over $55 trillion a decade ago, and the change in foreign exchange deals in April accounted for almost $5 trillion, two-thirds of daily global currency turnover.

For both non-US banks and non-US “non-banks” such as pension funds, dollar liabilities from currency swaps now double the dollar debt on balance sheets.

“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 on the scale and location of the problems was a key issue.

Off-balance sheet and off-balance sheet dollar debt


The report also assessed broader recent market developments.

BIS officials have been calling for strong rate hikes from central banks as inflation takes hold, but this time they were more measured.

Asked whether the end of the tightening cycle could be near next year, Claudio Borio, head of the BIS’s Monetary and Economic Department, said it would depend on how conditions develop, adding that the complexity of high debt levels and uncertainty about how vulnerable borrowers are now. noted the certainty. refers to ascending degrees.

The crisis in UK gilt markets in September also highlighted that central banks may be forced to step in and intervene by buying bonds, even as they raise interest rates to curb inflation.

“The simple answer is that one is closer than before, 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 it is known,” he added, referring to inflation. “But we have been fighting this battle for a long time.”

Market volatility


The report also pointed to findings from the BIS’s latest global foreign exchange market survey, which showed that $2.2 trillion worth of foreign exchange trades are at risk of defaulting on any given day due to problems between counterparties, potentially undermining financial stability.

The amount at risk is about a third of total deliverables and is up $1.9 trillion from three years ago when the last FX survey was conducted.

FX trading also continues to shift from multilateral trading platforms to “less visible” venues, preventing policymakers from “adequately monitoring foreign exchange markets”.

Hyun Song Shin, the Bank’s Research and Economic Adviser, meanwhile, described recent cryptocurrency market issues such as the FTX stock crash and stablecoin TerraUSD and Luna as having similar characteristics to bank crashes.

He described most of the cryptocurrency coins traded as “DINOs – decentralized in name only” and most of the activities associated with them were done through traditional intermediaries.

“It’s mostly people taking deposits in unregulated banks,” Shin said, adding that this is due to the elimination of large leverage and payment mismatches, as was the case during the financial crisis more than a decade ago.

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

Our standards: Thomson Reuters Trust Principles.

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