As a first approximation,6 FX swaps are exempt; repos included in full. This is surprising, given that the two instruments are roughly equivalent from an economic perspective. https://www.forexbox.info/best-online-brokers-of-august-2021/ 19 The counterparties of the central banks are not in all cases reporters to the BIS banking statistics, in which case they cannot help explain the gap identified previously.

1. Turnover data show that the modal forward (a customer-facing instrument) matures between one week and one year while the modal swap (an inter-dealer instrument) within a week (BIS (2016)).
2. Dollar dominance is striking in this FX market segment, greater than in any other aspect of dollar use.
3. Much of the missing dollar debt is likely to be hedging FX exposures, which, in principle, supports financial stability.
4. 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.

2 The estimate of outstanding FX swaps (separate from outright forwards) is derived from the Triennial survey, where turnover figures for these instruments are reported separately. In what follows, whenever we refer to funding via FX swaps, we have in mind combinations of spot and forward transactions. 13 Graphs 5 and 6 plot two estimates for net interbank borrowing (solid and dashed blue lines) and net FX swaps (shaded area and dashed black line). In the locational banking statistics, banks report cross-border inter-office positions.

To be sure, the investor may deal with different counterparties and face different operational issues. And, if market prices are not perfectly aligned, one strategy may pay off better than the others. In each case, the investor takes on foreign currency debt – in the form of a forward (case 1), the forward leg of the FX swap (case 2) or the amount borrowed in the cash repo market (case 3). And, in each, the investor must pay foreign currency to settle the maturing debt. Currency swaps are financial contracts between two parties to exchange a specific amount of one currency for an equivalent amount of another currency. The purpose of currency swaps is to reduce currency risk, achieve lower financing costs, or gain access to a foreign currency.

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

Our analysis has implications also for academic work on bank funding and lending patterns. That work generally has to rely exclusively on on-balance sheet data, for which the BIS international banking statistics are a key source. Authors should be aware and acknowledge that they are capturing only part of overall activity, often not even the larger one if the focus is on the US dollar. To be sure, we are not arguing for a specific treatment of repos and swaps.

If they suffered a loss due to fluctuating exchange rates affecting their business activity, the profit on the swap can offset that. Currency swaps have been tied to the London Interbank Offered Rate (LIBOR). LIBOR is the average interest rate that international banks use when https://www.forex-world.net/blog/stop-loss-stop-loss-order-trading-strategy/ borrowing from one another. It has been used as a benchmark for other international borrowers. During the financial crisis in 2008, the Federal Reserve allowed several developing countries that faced liquidity problems the option of a currency swap for borrowing purposes.

Second, central banks lend dollars via FX swaps against either their own currency or third currencies. Against foreign currencies, some central banks lend dollars via swaps in the management of their FX reserve portfolio. For instance, the Reserve Bank of Australia swaps US dollars for yen (Debelle (2017)).

Since the overall US holdings of foreign currency bonds were $600 billion at end-2015, a 50% hedge ratio would extrapolate to $300 billion. FX swaps were a key part of non-US banks’ total US dollar funding, amounting to an estimated $0.6 trillion, roughly 6% of the total in March 2017 (Graph 4). The rest, about $9.4 trillion, mostly took the form of deposits from US and non-US non-banks (red and blue areas), and dollar debt securities (yellow area). Inspection of the corresponding time series provides some evidence for these links (Graph 3, left-hand panel). Non-financials’ FX swaps/forwards (red line) co-move with world trade (black). Similarly, there is a visible, if weaker, co-movement between international bonds outstanding (yellow) and longer-term currency swaps (light blue).

First, it updates the stylised facts concerning FX swaps/forwards and currency swaps. Second, it measures the missing dollar debt for non-banks resident outside the United States, and for banks headquartered outside the United States. This 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. Thus, in times of crisis, policies to restore the smooth flow of short-term dollars in the financial system (eg central bank swap lines) are set in a fog. 20 In some cases, the authorities finance some foreign exchange reserves by swapping domestic currency into dollars.

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. A currency swap is a transaction in which two parties exchange an equivalent amount of money with each other but in different currencies. The parties are essentially loaning each other money and will repay the amounts at a specified date and exchange rate. The purpose could be to hedge exposure to exchange rate risk, to speculate on the direction of a currency, or to reduce the cost of borrowing in a foreign currency.

Currency swaps don’t need to appear on a company’s balance sheet, while a loan would. The parties involved in currency swaps are usually financial institutions, trading on their own or on behalf of a nonfinancial corporation. Currency swaps and FX forwards now account for a majority of the daily transactions in global currency markets, according to the Bank for International Settlements.

Related instruments

10 Dafermos et al (2022) argue that repos allow more leverage than swaps. Even so, the larger stock of swaps/forwards entails more dollar obligations than dollar repos. For instance, given the hundreds of billions of swaps of yen for dollars by Japanese banks, the Japanese authorities have encouraged their banks to extend the maturities of their swaps (Nakaso 2017). Schrimpf, A and V Sushko (2019a), “Sizing up global foreign exchange markets”, BIS Quarterly Review, December, pp. 21–38.

FX swaps and forwards: missing global debt?

See also Aldasoro et al (2017) for evidence of differential pricing in dollar funding markets; Japanese banks pay a premium to borrow via repos from US money market funds. 8 Only 1% of FX transactions are centrally cleared (Wooldridge (2017)), and most of those remain limited to non-deliverable forwards (McCauley and Shu (2016)). At end-2007, before interest rate swaps were centrally cleared, the inter-dealer share how do i buy nasdaq stock of such positions stood at almost 40%. Finally, currency swaps have limited liquidity, which makes it difficult to enter or exit a swap agreement at a favorable rate. Also, given the complexity of currency swaps, some financial institutions may find it difficult to use them effectively. The most common[citation needed] use of foreign exchange swaps is for institutions to fund their foreign exchange balances.

Similarly, if firms and governments use $2.4 trillion of currency swaps to hedge $4.8 trillion of international bonds, then they hedge half or less. In addition, some institutions use currency swaps to reduce exposure to anticipated fluctuations in exchange rates. For instance, companies are exposed to exchange rate risks when they conduct business internationally. 6 Non-banks in the United States had $866 billion in foreign currency debt in 2021 (US Treasury et al (2022)). About 5% of the $3.4 trillion in US imports were foreign currency-invoiced (Boz (2020)). Compared with $26 trillion in dollar debt, any borrowing of dollars in swaps/forwards to hedge these payables may be considered as a rounding error.