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Invest for a long time, borrow it and use as much as possible. This is the way to make money in finances. Banks always deserve their livelihood. But we also know very well that this story can end in panic runs for exit and the financial crises. This happened in the large financial crisis (GFC) from 2007-09. Since then, the bank for international settlements in its Most recent annual economic reportThe financial system has changed a lot. But it doesn’t have this central feature.
Also notes Hyun Song ShinEconomic advisor to the BIS, “despite the fragmentation of the real economy, the money and financial system is now closer than ever”. If this sounds like an accident that is waiting for it, you are quite right. Central banks must be ready to go to rescue.
The story that tells is a fascinating. Therefore, the consequences of the GFC did not make the system fundamentally different. It only changed who was involved. In the run -up to the crisis, the dominant form of lending was for the private sector, especially in the form of mortgages. The loan was then rejected to the private sector, while the creditworthiness exploded the governments. The pandemic accelerated this tendency.
That was not surprising: if people want to save and lend, someone else has to borrow and spend. This is macroeconomics 101. In addition to changing the change of direction, the intermediary was changed: instead of the large banks, global portfolio managers came. (See diagrams.)
As a result, cross -border binding stocks have increased enormously. What matters here are changes in the gross, not online, in the stocks. The latter are relevant for long -term sustainability macroeconomic rescue and expenses. The former are more relevant to the financial stability, since they drive changes in the financial leverage (and from), in particular cross -border leverage. Over and beyond, Notes Shin“The biggest increase in portfolios was between advanced economies, especially between the USA and Europe”. The emerging economies are relatively less involved in this lending.
How does this new cross -border financial system work? It has two basic features: the leading roles of foreign currency swaps and non-banking financial intermediaries.
Most of these cross-border loans consist of the purchase of dollar bonds, in particular from US state bonds. The foreign institutions that bought these bonds, such as pension funds, insurance companies and hedge funds, have dollar assets and domestic currency liability. Currency protection is essential. The banking sector plays a key role by enabling the market for foreign exchange swaps that provide these hedges. In addition, a forex swap is a “secured credit company”. However, these do not appear on balance sheets.
According to the outstanding forex swaps (including forward and currency change), 111 TN $ at the end of 2024, whereby Forex swaps and the forwarding of two thirds of this amount were taken into account. These are far more than cross -border bank claims ($ 40) and international bonds (29 m). In addition, the largest and fastest growing part of the market consists of contracts with non-dealer institutions. After all, around 90 percent of Forex swaps have the dollar on one side of the transaction and over three quarters of a ripe of less than a year.
As it determines, this highly non -transparent number of cross -border financing agreements also affects the transfer of monetary policy. One of the suggestions he makes is that the greater role of non -banks financial intermediaries, in particular hedge funds, “have contributed to correlated financial conditions in the countries”. Some of it is quite subtle. In view of the large-scale foreign property of US bonds, the conditions in the owners’ domestic markets can be transferred to the USA, for example. Here, too, exchange rate movements that influence the dollar value of investments in emerging market debts can trigger adjustments to their domestic prices.
What are the risks in this new financial system? As already mentioned, banks are active on the Forex swaps market. They also offer a large part of the repo financing for hedge funds that actively speculate on the bond market. In addition, according to over 70 percent of the bilateral repo financing of the banks, there are zero haircut. As a result, the lenders have very little control over the leverage of the hedge funds active in these markets. Last but not least, non-US banks are active for the financing of dollars for companies that work in these markets.
What does all that mean? Well, we now have closely integrated financial systems, especially in countries with high incomes, even if the federal states deal with political and with regard to their trade relationships. In addition, a large part of the funding in dollars is relatively short. It is easy to imagine that conditions under which the financing looks like may react in response to large movements in bond yields or another shock. As in the GFC and the pandemic, the Federal Reserve would have to go directly to other central banks, especially in Europe, as a lender of the last way out and via SWAP lines. We assume that the FED would actually come to rescue. But can this be considered for granted, especially after Jay Powell has been replaced next year?
The system that has to clarify the fragility of the traditional banking business, but even less transparency. We have a large number of non -regulated companies that take high -negative positions that are financed at short notice in order to invest in long -term assets, the market values of which may vary significantly, even if their capital values are ultimately secure. This system requires an active lender of the last way out and the willingness to maintain deep international cooperation in a crisis. It should work. But will it?
