Foreign Exchange Swaps: Hidden Debt, Lurking Vulnerability

Yves here. Anyone who remembers the crisis will recall that one of the critical elements that turned what should merely have been a housing crisis into a global financial crisis was that accounting rules allowed banks to record certain types of assets at zero risk weights, such as AAA rated CDOs with some additional insurance from an AAA guarantor…like AIG or the monolines, all of which went bust.

There are three reasons to scrutinize FX swaps (note this is the 50,000 foot statement of these issues). First, as this article points out, the peculiar accounting for FX swaps results in some of what is essentially debt to go unrecorded.

Second, currency mismatches were a big problem in the crisis, as European banks that held dollar assets (and a lot of that was US mortgage market related) found they had trouble rolling their dollar funding of it. The Fed had to throw open currency swap lines so that the ECB could swap its Euro emergency loans to these banks into the needed dollars.

Third, as we pointed out, foreign exchange swaps look to have played a significant role in the recent repo market strains. Our view has been that concern about the repo market interest spikes has been way way overdone; there’s no indication that the increases resulted from banks being reluctant to lend to counterparties, but instead to the Fed not understanding the implications of various changes it and Congress had made to how banks manage their liquidity, which got exposed when the Fed finally started tightening via shrinking it balance sheet. And to make matters worse, the Fed’s responses were late, clumsy, not well explained, and hence had the effect of making non-insiders suspicious.

John Dizard in the Financial Times pointed out that the reason big banks like JP Morgan who made clear they had ample liquidity but couldn’t be bothered to provide it to the repo market was that they were making more in foreign exchange swaps. From a September post, quoting Dizard:

Why have the Fed’s large interventions since September 17 not calmed the money markets? Perhaps it is because that liquidity is being sopped up by the demands of the FX swaps market.

Ralph Delguidice, a money market observer and global macro strategist at Pavilion Global of Montreal, points out that for a yen/dollar FX swap, “a dealer receives a total of about 230 basis points for what is a synthetic yen-dollar repo. That includes the three-month dollar Libor rate, the negative rate on Japan Libor, a charge by the dealer called the ‘basis’, and the negative yield on the JGBs which are the best place for the dealer to park the yen they receive in return for dollars.

“Compare that to dollar repo which was 190 earlier this week, and Treasury bills, which are about 150. You can see why the dealers are incentivised to lend dollars in the FX swap market rather than the domestic money market.”

Note finally that the Bank of International Settlements has been worried about hidden foreign exchange swaps debt since at least 2017. The fact that they have not gotten to the bottom of it is a cause for concern. Opacity and hidden leverage are prescriptions for disruption or worse.

The bottom line is foreigners’ “hidden” dollar borrowings via foreign exchange swaps look to be bigger than their visible on-balance sheet borrowings. This is not a pretty picture, and among other things, means that credit rating agencies and other financial analysts have a big blind spot.

By Claudio Borio, Head of the Monetary and Economic Department, Bank for International Settlements,Patrick McGuire, Head of International Banking and Financial Statistics, Monetary and Economic Department, Bank for International Settlements, and Robert McCauley, Corte Real Advisor. Originally published at VoxEU

Foreign exchange swaps and forwards are a key instrument in the global financial system for hedging, position-taking and short-term funding. They involve the exchange of notional amounts at a future date and, as funding vehicles, they are akin to other forms of collateralised borrowing (e.g. repo). The amounts involved are huge, but the instruments remain mysterious in some ways: because of an accounting peculiarity, they are treated very differently from other forms of collateralised debt. This column examines their geography and draws implications for both academics and policymakers. It finds that non-US residents’ US dollar forward payment obligations arising from foreign exchange swaps and forwards are likely to be even larger than the corresponding on-balance sheet US dollar debt. It also highlights the favourable regulatory treatment that these instruments receive, and argues that they represent a critical pressure point in international financial markets.

Foreign exchange (FX) swaps and their close cousins, FX forwards, are an important and growing segment of global financial markets.1 The latest BIS Triennial Survey indicates that, at $4.3 trillion, they accounted for some 65% of the average daily turnover in global FX trading in April 2019. In fact, they have been its fastest-growing component, accounting for roughly 75% of the increase in aggregate turnover since April 2016, the date of the previous survey (BIS 2019a, Schrimpf and Sushko 2019a). The amount outstanding at end-June 2019 was as high as $72 trillion, with FX swaps an estimated three-quarters of this total.2 For perspective, this figure was equivalent to 84% of global GDP, exceeded that of global cross-border portfolio stocks ($59 trillion) and international bank claims ($35 trillion), and was almost triple the value of global trade ($25 trillion). Not surprisingly, the US dollar reigns supreme. It is almost always one of the two currencies exchanged: 89% and 90% in terms of outstanding and turnover, respectively.

FX swaps and forwards play a key role in funding. Whenever an agent wishes to acquire, say, a US dollar asset on a hedged basis, they can do so in four ways: borrow dollars on an uncollateralised basis, enter a repo, enter an FX swap or, equivalently, combine a spot purchase of dollars with a forward sale, possibly with two different counterparties. The last three transactions are, in effect, forms of collateralised borrowing. It is only when an agent already has revenue streams and wishes to hedge them that they can simply use a forward. In this case, while not a financing vehicle, the forward is a form of debt. Of course, the instruments can also underpin speculative positions.

FX swaps and forwards differ from most other types of derivatives in one crucial respect: the notional amount is exchanged. They generate a debt obligation for the full face value of the contract. As a result, while notional amounts for other derivatives simply act as a reference for the much smaller amounts actually exchanged, the same is not true for FX swaps and forwards. Notional amounts must be paid and thus matter a great deal; in fact, there is nothing notional about them.

The special character of these instruments does not stop here (Borio et al. 2017). Their accounting treatment differs fundamentally from that of other forms of collateralised debt. Compare an FX swap with a repo. When an agent borrows against a security in a repo, the security stays on the balance sheet: the balance sheet is grossed up, as it includes the new borrowing and whatever is acquired through it. By contrast, if the same agent enters into an FX swap, using another currency as collateral, the new currency simply replaces the old one on the asset side of the balance sheet: the size of the balance sheet does not change.3 One transaction shows up as additional debt; the other is not treated as debt at all – the debt remains ‘hidden’. Why are instruments that are economically (roughly) equivalent treated so differently? Because accountants consider cash to be special.

This asymmetric treatment has important implications. One has to do with our understanding of the geography of FX swap and forward debt; the other with their regulatory treatment and financial stability implications more broadly. Consider each in turn.

The gGeography of FX Swap and Forward debt: US Dollars Outside the US

Out of sight may not quite be out of mind, but a lack of transparency does complicate things. When the Great Financial Crisis (GFC) broke out, the FX swap market came under substantial strain (Baba et al. 2009, McGuire and von Peter 2009), as funding in the wholesale unsecured segment froze. The extent of the strains took many by surprise, as did the underlying demand for US dollars, especially as this came from European banks. Had the amount of FX swaps and the banks in need been more broadly known, the surge would have been less unpredictable or at least more easily understood. The funding disruptions were so serious that they prompted major central banks to put in place FX swap arrangements to channel the necessary US dollar funding to those that needed it most.

McGuire and von Peter (2009) took a first stab at estimating non-US banks’ US dollar borrowing via FX swaps and forward debt more generally. Their key assumption was that banks generally avoided taking significant FX exposures, largely reflecting prudential regulations and risk management practices. In other words, they assumed that banks used FX swaps to ‘fill the gap’ in the net currency exposure shown on their balance sheets. Based on the same methodology, estimates of this gap derived from the BIS international banking statistics suggest that non-US banks’ net dollar borrowing via FX swaps was less than $1 trillion at end-June 2019. However, rough estimates based on some ancillary assumptions detailed in Borio et al. (2017) and derived from the BIS OTC derivatives statistics indicate that the corresponding gross amount exceeded $30 trillion, more than double their gross on-balance-sheet dollar debt ($13 trillion).4

What about the amount of US dollar debt in the form of FX swaps/forwards by non-banks (financial and non-financial entities) outside the US? Here, obtaining an estimate requires a triangulation between the aggregate amount of FX swaps/forwards outstanding and banks’ positions. Using the same ancillary assumptions, we estimate that, at end-June 2019, the amount was some $18 trillion or so. This was actually larger than the equivalent amount of on-balance sheet debt, estimated at $11.9 trillion.5

FX Swaps, Regulation, and Financial Stability

As a rule, prudential regulation generally follows accounting, with first-order implications for the treatment of FX swaps/forwards. Compare, again, an FX swap with a repo. While the corresponding cash flows are captured and treated equivalently in liquidity regulation, the picture is quite different for the leverage ratio in particular. 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.

The implications can be substantial. Precisely because the instruments are off-balance sheet, a systematic analysis is not possible. Still, we just saw how large non-US banks’ dollar borrowing (on net) via FX swaps is and how the figures are an order of magnitude larger for gross positions. The net-gross distinction is bound to be especially large for banks acting as market-makers, which have both long and short positions in the instrument.

To be sure, we are not arguing for a specific treatment of repos and swaps. Nor are we saying that the treatment needs to be identical, at least if the uses of the instruments and broader implications for financial stability are considered. Indeed, a key function of FX swaps is to facilitate hedging. We are simply saying that such a large difference is odd. The difference has implications for regulatory arbitrage, for market dynamics around reporting dates and for business models more generally.7 Appropriately, the Basel Committee on Banking Supervision (BCBS) is monitoring banks’ behavioural responses to regulations, including potential regulatory arbitrage transactions and balance sheet optimisation techniques (BCBS 2019c).

Looking forward, regardless of their regulatory treatment, FX swaps are likely to come under strain again should global financial markets face stress at some point. Their role in US dollar short-term funding is so large and important that it could not hardly be otherwise. Almost three quarters (72%) of the average daily turnover in April 2019 was in maturities up to one month, adding to rollover pressure.8 Any financial stress in this market could easily also engulf the shorter-term repo market: both compete for spare dollar funding, which is quite concentrated these days (Dizard 2019). And this at a time when the authorities are grooming secured interest rates to become the new reference (Schrimpf and Sushko 2019b). In fact, the direction of contagion could go either way. The surprising ructions of September 2019 in the US dollar repo market had only a limited effect on the FX swap segment (BIS 2019b). But, in periods of extreme stress, even fully collateralised markets can seize up, as the events of the GFC showed.


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. Both of these aspects deserve more attention than they have generally received so far.

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. Here as elsewhere, ‘caveat emptor’ applies.

Authors’ note: The views expressed are those of the authors and do not necessarily represent those of the Bank for International Settlements.



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 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. It is not possible to exclude NDFs from the outstanding amounts, although turnover data for these instruments suggest that they are a single-digit share of the market. Figures for the average daily turnover and amounts outstanding of FX swaps and forwards are taken from the BIS Triennial Survey and the semi-annual OTC derivatives statistics, respectively. Figures for internationally active banks’ net on-balance sheet open currency positions are derived from the BIS international banking statistics.

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.

3 Outright forwards combined with a spot transaction with a different counterparty would be recorded similarly.

4 In addition to market-making activities (see below), the gross figure is boosted by the vehicle currency role of the US dollar. For instance, a European institution seeking to invest in a Thai baht asset may swap euro for dollars and then dollars for baht, i.e. both borrow and lend dollars via FX swaps.

5 See the BIS Global Liquidity Indicators for background.

6 This relates to counterparty risk, in the form of the market value of the instrument (replacement cost) and potential future exposures, which are included in both cases. But these are tiny in comparison to the principal amounts. For details, see BCBS (2019a).

7 For instance, it is well known that banks “window-dress” their balance sheets around reporting dates (BIS 2018, Behn et al. 02018). Indeed, the Basel Committee on Banking Supervision has issued guidance to address this problem (BCBS 2019b, 2018). Not least because of the regulatory treatment, the adjustment takes place largely via repos.

8 Of course, some authorities have been very alert to such risks. 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).

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  1. Louis Fyne

    Banks around the world are too big.

    (in my opinion) no US bank should have more assets than $500 billion, (at that size only around 10 US banks, if I recall correctly, need to be broken up or charged a very punitive excise tax). and that cap should only rise with US GDP.

    And if other countries want their own version of the Icelandic-Irish bank crisis, go for it. good luck

    unfortunately given the political climate, lobbying and advert spending power of the banks, breaking up the banks is barely on the 2020 radar. ironically, many on the populist left and populist right would welcome such move.

    With the alleged rumors of a possible Bloomberg-Clinton ticket, two generations ago it would’ve been inconceivable that the Democrats could even be represented by a ticket tied at the hip to Wall Street.

  2. vlade

    With FX swaps, one has to be _very_ careful what one is looking at.

    There are “FX swaps”. Which are really two forwards, no interest rate payments, literally just the FX forwards. These tend to be relatively short – usually <12 months.

    Then there are cross-currency swaps. These have notional exchanges as well – but the initial and the final are exactly the same – because there are interest rate payments in between.

    These may be _very_ long (10 years isn't unusual, and when tied to some debt to support rating can be as long as 50 years). Also, because the final notional exchange is at the same FX as the initial, they can accumulate _very_ (and I mean VERY) large credit exposure. As in multiple of notional, often in hundreds of millions or even billions (remember, we're talking single swap here).
    That said, a lot of those are asset/liability matched – but only on one side. I.e. issuer may have EUR liability and GBP assets – the swap is there purely to be able to pay a predetermined EUR coupon.

    The bank that wrote this may have a bigger problem (and a lot of them did around 2010), which then can lead to a problem for the issuer (the rating for the issue depends on the swap being there, for reasons too long for a single post).

    In theory, it can hedge these xcy swaps into market, but in practice, the market (intrabank) swaps are usually actually principal-resetting. I.e. every now and then the FX notionals get reset according to the then current FX rate. Which, in practice, can realise PnL for the bank.

    There are a few further complicating elements.
    In practive, if the xcy swap is issuance-supporting (which it often is), then the bank doesn't really care too much (well, it does some, but then we actually get into some further complications that are too long for the post) about the credit quality of the cpty – because in effect it lent against collateral (so it cares about the quality of the collateral and that's where it can get fairly complicated).

    But more often the problem may be actually on the banks side. I.e. that the bank owest way too much to the cpty, and that often makes the swap un-novatable (i.e. the cpty can't easily switch to another bank) and the bank failure may cause failure of supported issuances. There is pretty much always some collateral agreement to protect the cpty (not the bank! Raters don't allow that), but in practice it's often not sufficient as the marking party for the collateral is the bank and it usually marks the swap to a price which is not really the market price (because there isn't one, just theoretical price, but no-one will deal on that on these swaps).

    TLDR; version – be careful what you call an FX swap, as the field is pretty complicated even if it looks relatively simple.

    1. Quill

      Thank you. Well written.

      With the first type of FX Swap, the value is way less than the notional and these are a significant portion of the swaps in existence. And, the fact that notional amounts are exchanged doesn’t (mostly) matter and notional rally doesn’t provide in that context any more of a useful measure than in most other contexts.

      1. OpenThePodBayDoorsHAL

        I think our financial and monetary systems are like giant electric motors, we use big motors all the time to drive everything but if you ask a scientist to explain how and why magnets fundamentally work (creating electron flow when wires pass over them), they can’t. We’ve created an unbelievably complex interoperating finance machine…but no one really knows in toto how and why it behaves the way it does.

        That’s either very comforting, or completely terrifying.

      2. vlade

        oh, if you wanted complex, I could go into how the fact that the swap is un-novatable could trigger forced bond sales (because of automatic downgrades attached). And the problem there is that you can’t circuit-break it easily, because a lot of this is contractual (meant to run on autopilot), and if you do break it, lawyers will have a feast. And counterfactual force-majeure is always fun, depending on your jurisdiction (i.e. when one side argues in the court that if they didn’t break it, really bad things would happen, and the other side saying nothign happened and nothing would have happened, so pay up).

        That said, IMO one of the problems here is that even sophisticated investors don’t really understand the whole infrastructure most of their deals uses.

  3. Chauncey Gardiner

    Thank you for this post and your insightful observations in the intro, Yves, and to the BIS economists for their intelligence and research in highlighting this issue. What a lovely state of affairs.

    If I’m understanding this correctly, in terms of raw supply and demand there is a shortage of US dollars as the primary global reserve currency that is fueling a need for dollar FX swaps to address dollar debts created by previous speculations in dollar FX swaps. Because of the magnitude of the risk exposures, perhaps we should flip then Treasury Secretary John Connally’s 1971 statement to now say, “The dollar is your currency, but it’s our problem.”

    Little wonder the Fed has not been more forthcoming in congressional testimony about the difficulty of reconciling this issue. Opacity and hidden leverage indeed. Raises further concerns about the sheer volume of derivatives speculations by the so called “Too Big To Fail” banks and other systemically important financial institutions off-balance sheet derivatives; not only in foreign exchange swaps, but in equity markets, interest rates, and credit default swaps.

    Why should We the People need to be concerned about the volume of speculation in and complexities of “synthetic yen-dollar repos” or any of the other massive off-balance sheet speculations by these people that, as in the financial crisis of 2008, may again be placing our depository institutions and payments system at risk? And to what extent is this horse driving the cart in terms of constraining implementation of macroprudential monetary policies domestically? I think the events in the repo market in mid-September 2019 and subsequent Fed policy gave us a hint about this. Congratulations to the TBTFs’ current and past CEOs and their lobbyists: You bought it, you own it.

    1. TiPs

      I’ve been thinking about this for some time, is there ANY constraint on the size of derivative markets? While we focus on banks’ ability to create money via loans, they are at least somewhat constrained by Basel cap ratios. However, it appears there is NO similar constraint on derivative creation, especially when activities like FX swaps are off-balance sheet.

      1. vlade


        Banks have to hold capital for derivatives, via a number of measures, most of which translate into “Risk Weighted Assets” which then attract (regulatory) capital charge.

        We can discuss (and people do) how good are the various measures, but saying there are no constraints on derivatives is just plain wrong [and here I’d add one thing – most regulators can, at their discretion, tell any under their regulation to increase capital pronto. Usually they don’t w/o some warning ahead as it could in effect kill the bank in a similar way a run would]

        1. TiPs

          Thanks for the correction. Given the size of the markets, it appears there is a lot of flexibility in creating derivatives. Based on this piece, I’m currently reading up on the accounting…

  4. chuck roast

    Thank you Yves. I am your standard genius-boy couch potato, and I would not pretend to understand the precise mechanisms of these arcane trades. However, with a close reading of this and associated links makes me feel like a blind pig turning up the same old nuggets:

    “regulatory arbitrage;” “the instruments are off-balance sheet;” “a lack of transparency does complicate things;” “the favourable regulatory treatment that these instruments receive;” “non-banks outside the United States owe large sums of dollars off-balance sheet through these instruments;” “this debt is, in effect, missing;”
    and my personal favorite:
    “for FX swaps and forwards. Notional amounts must be paid and thus matter a great deal; in fact, there is nothing notional about them.”

    This fellow Claudio Borio seems to doing his best to shine a light on these latest banker shenanigans. We can only hope that the fog lifts before these clowns run us aground again.

    1. Susan the other

      I know, cr. I’m definitely in your camp. 84% of global GDP. That’s assuming there is a GDP worth accounting for. In a world that is rapidly falling apart something tells me this 84% of GDP will be too massive to deal with. No wonder FX swaps aren’t connected to secured debt. Had they been, the world would have stopped functioning 20+ years ago. Makes me imagine of a global sovereign that looks at all the fudging going on just to keep an economy going when all hope is lost, and says – OK then, time for a big fat jubilee. I’d like that. Uncle Warren probably wouldn’t.

  5. Michael

    Once again it seems we had to weather a public event, Repo failure, in order to get behind the curtain and expose the true culprit de jour, FX.

    Looking back, if I understood ex fed staffer Zoltan’s early warnings about the coming Repo funding failures, it seems banks pulled liquidity to tackle a more significant problem, FX. As far as not enough USD in worldwide circulation, I need help understanding how our $T deficits aren’t enuf.

    Hence, the poor man’s problem of Repo funding seems again to be too few chairs when the music stops. The Fed had to step in! TINA! Assuming constant availability of rollover funding at your existing low rate seems like a model flaw. Hedge Funds should be made to eat the increased interest rate from their balance sheet. Might instill some discipline. The world won’t come to end…

    1. Susan the other

      Just wondering, can you swap your FX swap kinda like a carry trade until you manage to get a currency that gives you a positive return on your little insurance-derivative of some original debt backed by more debt collateral (not asset). Is this insane?

    2. Yves Smith Post author

      Actually, the BIS has been worried about FX swaps for a while, but the repo mess may start to lead regulators to take this serious.

      The BIS has a very weird status; it does not regulate banks but it can influence regulators. It was on to the housing bubble very early (the same Borio who was the lead author of this piece plus William White, now retired) were waring of a cross-country housing bubble starting in 2003. They were pooh poohed, basically for their argument only being empirical!

  6. drumlin woodchuckles

    I find all the details and mechanisms of this as difficult to understand as I found the mechanisms of past episodes of pre-meltdown-runup financial engineering. But it is easy to understand that my simple little on-balance-sheet life is put in financial danger when all the off-balance-sheet chickens come home to roost on the balance sheet.

    I think we could all benefit from some deep and broad and widely distributed pre-emptive and defensive decoupling.

    I hope NaCap chooses to start running articles on how individuals, communities, families, small-to-medium jurisdictions, etc can decouple themselves from the financial and moneyconomic systems which these or other clever financial engineering technologies will reach out and touch at some surprising black swan moment.

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