In its latest quarterly review, the Bank for International Settlements (BIS) suggested that the amount owed on foreign exchange swaps, forwards and currency swaps could precipitate a financial crisis.
The BIS said that non-bank financial institutions and funds had some $80 trillion of what it described as “hidden” off-balance sheet debt via FX swaps, a level that was more than all dollar Treasury bills, repo and commercial paper.
US Federal Reserve interest rate policy over the last decade or so meant that rates of return for cash became relatively and steadily more attractive through USD assets than in local currency for banks and non-banking institutions such as pension funds.
Since availability of USD-denominated credit lines for foreign institutions is limited, an effective method of increasing exposure to dollar assets was to simply convert local currency into USD, invest in the underlying asset, and take out a concurrent forward contract to convert the USD back into local currency at a specified point in the future.
In its report, the BIS said that payment obligations from FX swaps were recorded off-balance sheets, unlike with repo agreements.
There are ways to do derivative trades that are not reflected on financial statements...
