The Bank of International Settlements (BIS) is a relatively unheard of bank, for most. The so-called “central bank to the world’s central banks,” the BIS ensures that international capital flows can continue on a regular basis. However, what has perked up the ears of many investors and doomsayers are calls for concern from the BIS in its latest quarterly report, noting a potential $80 trillion FX swap debt “blind spot.”
You read that right. There’s a potential $80 trillion of capital that’s being held in shadow banks and non-US banks, essentially hidden from the ledgers of the BIS. This is a staggering amount of money, with some estimates putting the amount at roughly 14% of all financial assets globally.
With mounting global macroeconomic concerns tied to rising interest rates and inflation, this isn’t easy news to hear. Many investors who are already taking bearish positions may look to such data as the latest reason to sell.
Let’s dive into what this news means for the average investor.
What Does $80 Trillion of Hidden FX Swap Debt Mean?
Let’s start with what an FX swap really is. Foreign currency exchange swaps (FX swaps) allow banks and large institutions to swap interest payments on one loan made in a local currency with another in a foreign currency. In other words, two companies can swap their debt amounts, paying the interest in dollars other than their own.
There are many reasons why these swaps are made. Most commonly, multinational companies or banks may be looking to hedge foreign exchange risk. If a U.S. company with operations in Europe wants to borrow euros but can only get loans in U.S. dollars, for example, making interest payments in euros (where revenues are generated) may help balance out exchange rate losses from a depreciating euro. If the currency declines in value, so does the interest payments on the loan (on a relative basis, keeping the ROI of an investment intact).
That said, like all derivatives, the market for swaps is very complex. Other banks and large institutions use swaps for hedges or relatively cheaper financing. But when done through unregulated banks (shadow banks), the risks of these hedges can outweigh the value they provide.
Thus, central bankers at the BIS appear concerned about the potential ramifications of too much money trading hands in the shadows. We’ve gone through one financial crisis already. Accordingly, there are worries that the scale of such transactions could lead to problems on the horizon.
For most investors, it’s unclear what the ultimate impact of an FX swap crisis would be. Some might say that if the global market for FX swaps tanks, then it’s all over anyway. Others might suggest that central banks have dealt with these scenarios in the past. It’s just another thing to worry about, for those already concerned about these troubling markets.
On the date of publication, Chris MacDonald did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
