BIS Highlights “Unseen” Dollar Debt in FX Swaps
Posted by Colin Lambert. Last updated: December 6, 2022
In its latest Quarterly Review, the Bank for International Settlements (BIS) seeks to highlights the challenge of “huge, unseen dollar borrowing” embedded in the FX market.
Observing that FX swaps, outright forwards and currency swaps create forward dollar obligations, the BIS says that these contracts account for $26 trillion of “missing debt”, up from $17 trillion in 2016, and that non-US banks owe $39 trillion. Furthermore, non-bank financial intermediaries hold some $26 trillion in US dollar debt, the article adds, further noting that the $80 trillion-plus in outstanding obligations to pay US dollars in these contracts, mostly very short-term, exceeds the stocks of dollar Treasury bills, repo and commercial paper combined.
Of the $26 trillion dollar debt from non-bank financial intermediaries, the article says this is likely owed by entities outside the United States, for which the dollar is a foreign currency. “They borrow dollars largely to hedge their dollar receivables and investments in a world in which the dollar is the dominant international currency,” it states. “By contrast, NBFIs in the United States hedge their modest foreign currency assets by lending – not borrowing – dollars via FX swaps.”
It adds that businesses in the US have scant foreign currency payables to hedge by borrowing dollars off-balance sheet and that the off-balance sheet US dollar debt of non-banks outside the US substantially exceeds their on-balance sheet debt and has been growing faster. At end-June 2022, the missing debt amounted to as much as double the on-balance sheet component, which was estimated at “only” $13 trillion. Moreover, the missing debt was “only” 1.6 times larger in 2016, the article states.
For their part, banks headquartered outside the United States, including some dealers in FX swaps, have even larger missing dollar obligations. “These banks deserve focus because of their limited access to the Federal Reserve’s discount window for dollars,” the article suggests, adding their estimated off-balance sheet dollar obligations of $39 trillion at end-June 2022 were much higher than the $15 trillion in on-balance sheet dollar debt and almost half as big as their combined total liabilities.
The Full FX View
There are, without doubt, funding squeezes in dollar-denominated FX swaps markets, but as I have written recently, these are as much about the impact of capital regulation than market functioning.
In reality, what the authors are asking for here is more data, because while it is true that there is a shortage of dollars on occasion, this is more the result of it being the global reserve currency rather than the “fault” of the FX swaps market as some writers appear to have framed it.
Yes, there are huge dollar debts, but they are not sitting on a balance sheet having to be repaid out of cashflow as other debts are – they are fully funded and the only real risk involved is exchange rate risk.
One more point from this report, concerning non-bank financial intermediaries. There is no doubt that NBFIs are holding more risk, this is what happens when the risk warehousers are hamstrung by capital rules, but it should be pointed out that under the BIS criteria, a large number of smaller banks are included in the “Other Financial Institutions” category used by the authors in their analysis.
There are going to be funding squeezes no doubt, but they are a result of the global economic picture rather than a shortcoming, or huge risk emanating from the FX market.
The article argues that off-balance sheet dollar debt poses particular policy challenges because standard debt statistics miss it. The lack of direct information makes it harder for policymakers to anticipate the scale and geography of dollar rollover needs. This points to a need for statistics that track the geography of outstanding short-term dollar payment obligations, it argues. Currently, in order to assess the level and maturity structure of foreign currency gross and net debt, analysts tend to rely on benchmark international statistical collections, which generally cover only the on-balance sheet positions. “It is not even clear how many analysts are aware of the existence of the large off-balance sheet obligations. This makes it difficult to anticipate the scale and geography of dollar rollover needs,” the authors write.
“Off-balance sheet dollar debt may remain out of sight and out of mind, but only until the next time dollar funding liquidity is squeezed,” the article concludes. “Then, the hidden leverage and maturity mismatch in pension funds’ and insurance companies’ portfolios – generally supposed to be long-only – could pose a policy challenge. And policies to restore the flow of dollars would still be set in a fog.”