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Date Posted: 9:58:32 4/15/23 Sat
Author: Jasper
Subject: More

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Furthermore, the fact that banks’ accounts are prepared in accordance with the approval of regulators means that they should still be treated with scepticism. For example, why is it that derivative obligations are not properly accounted for in assessing the condition of individual banks, when repos, which are similar obligations, are? Derivative obligations are far larger for some banks than the entire balance sheets of the combined banking systems, and even national GDPs. The table below show the derivative exposure of the twenty most exposed US banks, and the ratio of derivatives to customer deposits, which are the principal source of balance sheet funding.

Admittedly, not all derivative risk should be measured by their notional amount. Credit default swaps, which are likely to predominate in domestic banking activities, do not commit participants to settling their notional amounts, which are reference values only. But foreign exchange forwards and swaps and commodity derivatives as well as sold options do expose banks and other participants to settling their full amounts. Foreign exchange dollar exposure for US banks alone was estimated in a recent BIS paper at $80+ trillion, four times US GDP, and which included the following commentary:

“Embedded in the foreign exchange (FX) market is huge, unseen dollar borrowing. In an FX swap, for instance, a Dutch pension fund or Japanese insurer borrows dollars and lends euro or yen in the “spot leg”, and later repays the dollars and receives euro or yen in the “forward leg”. Thus, an FX swap, along with its close cousin, a currency swap, resembles a repurchase agreement, or repo, with a currency rather than a security as “collateral”. Unlike repo, the payment obligations from these instruments are recorded off-balance sheet, in a blind spot. The $80 trillion-plus in outstanding obligations to pay US dollars in FX swaps/forwards and currency swaps, mostly very short-term, exceeds the stocks of dollar Treasury bills, repo and commercial paper combined. The churn of deals approached $5 trillion per day in April 2022, two thirds of daily global FX turnover.”



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