by Jan Skoyles, GoldCore:
– Global debt bubble may be understated by $13 trillion: BIS
– ‘Central banks central bank’ warns enormous liabilities have accrued in FX swaps, currency swaps & ‘forwards’
– Risk of new liquidity crunch and global debt crisis
– “The debt remains obscured from view…” warn BIS
Global debt may be under-reported by around $13 trillion because traditional accounting practices exclude foreign exchange derivatives used to hedge international trade and foreign currency bonds, the BIS said on Sunday.
Bank for International Settlements researchers said it was hard to assess the risk this “missing” debt poses, but that the main worry was a liquidity crunch like the one that seized FX swap and forwards markets during the financial crisis.
The $13 trillion unaccounted-for exposure exceeds the on-balance-sheet debt of $10.7 trillion that data shows was owed by firms and governments outside the United States at end-March.
The fact these FX derivatives do not appear on financial and non-financial institutions’ balance sheets under current accounting rules means little is known about where the debt lies.
“The debt remains obscured from view,” Claudio Borio, head of the BIS’s monetary and economic department, and two colleagues, Robert McCauley and Patrick McGuire, said in its latest quarterly report.
“Accounting conventions leave it mostly off-balance sheet, as a derivative, even though it is in effect a secured loan with principal to be repaid in full at maturity,” BIS said.
Explaining the risk they added: “In particular, the short maturity of most FX swaps and forwards can create big maturity mismatches and hence generate large liquidity demands, especially during times of stress.”
When buying a foreign asset, a domestic investor has three choices: buy a currency forward, undertake an FX swap or do a repurchase transaction.
But while the first two are recorded on balance sheets on a net basis without taking the notional amount into consideration, a repo transaction is recorded on a gross basis, when all these three types of trades are essentially similar – secured debt.
All these trades are used to remove the foreign exchange risk in a purchase of foreign securities.
In a swap, two parties exchange currencies and agree to reverse the swap later. In a forward contract the parties agree to exchange currencies at a fixed date and price in the future.