FX swaps and forwards: missing global debt?

Whereas dollar-lending central banks typically have a long FX position, dollar-borrowing central banks can hold reserves while also avoiding a long FX position. This makes it very difficult to measure the debt and funding involved. The balance sheets show only the final outcome of a series of swap and forward transactions. For instance, if a bank swaps its home currency for dollars, its dollar assets https://www.day-trading.info/10-most-valuable-currencies-in-africa/ end up exceeding its dollar liabilities. Moreover, for highly active dealer banks, the balance sheet shows only the net result of a possibly huge number of deals for dealer banks very active in the market. Swaps can last for years, depending on the individual agreement, so the spot market’s exchange rate between the two currencies in question can change dramatically during the life of the trade.

The $80 trillion-plus in outstanding obligations to pay US dollars in FX swaps/forwards and currency swaps, mostly very short-term, exceeds the stocks of dollar Treasury bills, repo and commercial paper combined. The churn of deals approached $5 trillion per day in April 2022, two thirds of daily global FX turnover. The first source is the BIS derivatives statistics, which draw on reports from 73 global dealer banks. FX swaps and forwards are treated together since, as noted above, after the spot exchange only the forward position survives. That said, BIS statistics on FX turnover show that FX swaps are the modal instrument (see below).

  1. It has reached $26 trillion for non-banks outside the United States, double their on-balance sheet debt.
  2. In a currency swap, or FX swap, the counterparties exchange given amounts in the two currencies.
  3. Markets calmed only after coordinated central bank swap lines to supply dollars to non-US banks became unlimited in October 2008.
  4. Thus, one can relate non-financial FX swaps/forwards and currency swaps, in an admittedly stylised fashion, to international trade and bond issuance, respectively (Table 1).

The market turmoil during the GFC and in March 2020 highlighted the central role of the US dollar in the financial system. In each episode, disruptions in dollar funding markets led to an extraordinary policy response in the form of central bank swap lines, whereby the Federal Reserve channelled US dollars to key central banks. FX swaps/forwards are a critical segment of global financial markets. Despite their role, the geography of their utilisation remains opaque. And, largely because of accounting conventions, their regulatory treatment differs markedly from that of instruments that, economically, are also forms of secured debt.

Why use currency swaps?

1 The quantitative estimates of in this column are an aggregate of FX swaps, FX forwards and currency swaps, since separate statistics are generally not available for outstanding amounts. Currency swaps are FX swaps with a maturity longer https://www.topforexnews.org/brokers/teletrade-analytics-on-the-appstore/ than one year in which coupons are also exchanged. Our aggregate also includes non-deliverable forwards (NDFs), or forwards where the notional amount is not exchanged, making them materially different from swaps and deliverable forwards.

Dollar debt in FX swaps and forwards: huge, missing and growing

This means that there is a risk that one of the parties may default on their obligations. Foreign currency swaps can be arranged for loans with maturities as long as 10 years. Currency swaps differ from interest rate swaps in that they can also involve principal exchanges. The forward rate is the exchange rate on a future transaction, determined between the parties, and is usually based on the expectations of the relative appreciation/depreciation of the currencies. Expectations stem from the interest rates offered by the currencies, as demonstrated in the interest rate parity. If currency A offers a higher interest rate, it is to compensate for expected depreciation against currency B and vice versa.

Foreign exchange swaps: Hidden debt, lurking vulnerability

In particular, German, Swiss and UK banks reduced their combined reliance on FX swaps from $580 billion in 2007 to less than $130 billion by end-Q1 2017. The outstanding amount has quadrupled since the early 2000s but has grown unevenly (Graph 1, left-hand panel). After tripling in the five years to 2007, it fell back sharply during the GFC, even more than international bank credit. This most likely reflected a reduction in hedging needs, as both trade and asset prices collapsed. The first foreign currency swap is purported to have taken place in 1981 between the World Bank and IBM Corporation. Then, they can unfold the swap later when the hedge is no longer needed.

However, given the activity of hedge funds in the currency swap market, the 80% should be regarded as an upper bound on non-bank financial firms’ hedging. The outstanding amounts of FX swaps/forwards and currency swaps stood at $58 trillion at end-December 2016 (Graph 1, left-hand panel). Other financial instruments can be used in lieu of currency swaps.

Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Behn, M, G Mangiante, L Parisi and M Wedow (2018), “Does the G-SIB framework incentivise Best index funds 2021 window-dressing behaviour? Evidence of G-SIBs and reporting banks”, ECB Macroprudential Bulletin 6, October. 16 See ABS (2013) and Rush et al (2013) on hedging by Australian banks.

What is a Foreign Exchange Swap?

For all open access content, the Creative Commons licensing terms apply. McGuire, P and G von Peter (2009), “The US dollar shortage in global banking”, BIS Quarterly Review, March, pp. 47–63. The exchange between them is based on a $1.2 spot rate, indexed to LIBOR. The two companies make the deal because it allows them to borrow the respective currencies at a favorable rate. A common reason to employ a currency swap is to secure cheaper debt. For example, say that European Company A borrows $120 million from U.S.

When hedging bond issues in foreign currency, firms and governments typically match the bond maturity and that of the currency swap (McBrady et al (2010), Munro and Wooldridge (2010)). One reason is that forwards and swaps are treated as derivatives, so that only the net value is recorded at fair value, while repurchase transactions are not. Since the value of the forward claim exchanged at inception is the same, the fair value of the contract is zero and it changes only with variations in exchange rates. Yet, unlike with most derivatives, the full notional amount, not just a net amount as in a contract for difference, is exchanged at maturity. That is, the notional amounts are not purely used as reference for the income streams to be exchanged, such as in interest rate derivatives.

The only difference is that in case 3 the agent has the freedom to use the domestic currency cash to buy another domestic currency asset rather than having it tied up in a forward claim. Foreign currency swaps can involve the exchange of fixed rate interest payments on currencies. Or, one party to the agreement may exchange a fixed rate interest payment for the floating rate interest payment of the other party. A swap agreement may also involve the exchange of the floating rate interest payments of both parties. In a cross currency swap, both parties must pay periodic interest payments in the currency they are borrowing. Unlike a foreign exchange swap where the parties own the amount they are swapping, cross currency swap parties are lending the amount from their domestic bank and then swapping the loans.






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