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The Hidden World of FX Swaps A Behind-the-Scenes Look at Global Currency Flows Trillions of dollars flow silently through the global financial system each day, largely unnoticed. These hidden currents take the form of FX swaps, short-term derivatives that exchange currencies today with a promise to reverse the trade in the future. "A typical day sees almost $4 trillion in new FX swap contracts," notes a recent report from the Bank for International Settlements (BIS). While invisible on balance sheets, these instruments create huge payment obligations between the world's largest banks. The BIS report sheds light on this murky corner of finance by combining two datasets. Bank balance sheet data from the BIS statistics show on-balance sheet currency positions. Special data from CLS, a large FX settlement system, provide a detailed breakdown of banks' off-balance sheet positions in FX swaps settled through CLS. Together, these datasets reveal fascinating insights into how major banks use FX swaps to move dollars and other currencies around the world. Follow the Money First, the scale. Outstanding FX swaps and forwards amounted to a staggering $66 trillion in mid-2022, more than global GDP. The vast majority, around 90%, involved dollar payments. A handful of big banks dominate, with US banks controlling around a third of the global market. Their pivotal role makes monitoring their FX swap positions essential for tracking dollar funding flows. Banks use FX swaps in three main ways: 1. Hedging on-balance sheet currency exposures. 2. Arbitraging interest rate differences across currencies. 3. Market-making for clients. In practice, banks treat the positions from these activities fungible, managing the overall net position. Lucrative Dollar Lending The BIS-CLS data show that major US and Eurozone banks have ramped up net dollar lending via FX swaps dramatically since 2013. Their combined net dollar lending surpassed $1 trillion by early 2021. What drove this surge? With dollar premiums over funding costs in euros and yen having widened significantly, dollar lending via FX swaps became very profitable. Banks with ample dollar funding took advantage. Japanese banks, meanwhile, have been consistent net borrowers of dollars in FX swaps. Japanese life insurers and other institutional investors make heavy use of dollar swaps to hedge the currency risk of their huge foreign asset holdings. Accommodating Clients Banks turn to the interbank FX swap market to offset imbalances in their derivative positions with clients. The data show banks adjusting interbank swaps as customer demand for currency hedges changes. For example, as US banks' estimated net dollar lending to customers grew between 2016 to 2020, they funded this mainly by borrowing dollars from other banks in interbank swaps. Eurozone banks did similar. These interbank swaps allow banks to accommodate clients' hedging needs without expanding balance sheets. The Kingpins US banks stand out as the key FX swap intermediaries between banks and non-banks globally. In particular, Eurozone and Japanese banks relying on dollar swaps tend to transact mainly with US banks rather than directly with each other. In addition, US banks engage in maturity transformation that is unique. They borrow dollars short-term from banks to lend long-term to non-bank customers. This makes US banks net borrowers of dollars on the interbank market, even as they act as overall dollar providers. In short, US banks are the pivot point directing global currents of dollars through the FX swap market. Their positioning and activities have major implications for dollar funding conditions globally. Murky Risks The BIS report concludes that detailed monitoring of banks' FX swap positions is essential for financial stability. The huge off-balance sheet payment obligations make the FX swap market prone to periodic seize-ups. Recent history shows that when this corner of dollar funding markets freezes up, it takes extraordinary central bank interventions to unblock the plumbing. Given US banks' centrality, monitoring their FX swap books is vital to tracking dollar liquidity risks. The opaque nature of FX swaps allows banks' dollar liabilities to balloon out of sight. The next crisis may very well start with the sudden revealing of some uncomfortable truths about the trillions swirling silently through this hidden dimension of finance. This summary was made with the help of Claude, an AI assistant. Via this post I have learned more about the current financial system and I hope that in a way, it helps you as well. You can find the full report here: bis.org/publ/qtrpdf/r_…

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The most impactful lesson I've learned this week. Let your fears guide you. Terrifying right? Especially when your fears hijack your body and mind, and scream at you that your life is in danger. Like mine do with raging PTSD. Here's the thing though: that's all fear is, a feeling, just a chemical reaction inside your body. Unless there's a tiger there, ready to eat you, many fears are just stories your subconscious tells you. Actionable takeaway: Next time you're afraid of: 🔸Having a tough conversation 🔸Speaking in public 🔸Reaching out to someone new Stop. Breath. Sit with it and let yourself feel it. While you can't change your body's response, you CAN change your mindset. The Alpha: 🔸Tell yourself you're safe 🔸Challenge yourself to be brave 🔸Know that by facing your fear, regardless of the outcome, you will grow confidence and find amazing opportunities. This is how we grow. What fear will you face today? Build this new habit now.

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