The growing load of hidden leverage has swelled to a massive $65 trillion in a largely obscure corner of the foreign exchange market, economists at the Bank for International Settlements warned Monday—making it more difficult to levy the risks lying in the financial sector as experts worry about possible triggers for another global financial meltdown.

Key Facts

In a quarterly report published Monday, the BIS reported financial institutions such as pension funds, insurers and shadow banks outside the U.S. have $65 trillion in U.S. dollar debt through foreign-exchange swaps, forwards and currency swaps that aren’t recorded on balance sheets—representing “a large and growing volume of missing U.S. dollar debt.”

Due to the growing use of shadow banking in the swaps markets, analysts and credit ratings agencies are unable to track these liabilities, which typically mature in less than a year and are already vulnerable to funding squeezes (in which borrowers can’t access the capital), economists Claudio Borio, Robert McCauley and Patrick McGuire warned in the report.

“It is not even clear how many analysts are aware of the existence of the large off-balance sheet obligations,” the economists said, cautioning past funding scares were “flash points” of the Covid market meltdown and Great Financial Crisis—forcing the Federal Reserve to shore up dollar liquidity to prevent severe market disruptions.

Without intervention, any turmoil could force borrowers to pay high interest rates—or potentially sell off other assets at steep discounts—as they scramble to make due on debts without being able to access their dollars, the economists said.

After instability in the U.K. bond market this October prompted unprecedented intervention by the Bank of England (which warned the turmoil posed a “material risk” for Europe’s economy), Tobias Adrian of the International Monetary Fund cautioned such hidden leverage was among concerns that could provoke “market dysfunction” in other countries.

In a Financial Times interview, Amundi chief investment officer Vincent Mortier called the chaos “a reminder that shadow banking is a reality” as he warned the resulting challenges are now “much more difficult than in 2007, when leverage was predominantly in the banks,” and pointed to the swift collapse of Archegos Capital Management as an example of the risks.

Crucial Quote

“Off-balance-sheet dollar debt may remain out of sight and out of mind—but only until the next time dollar funding liquidity is squeezed,” the analysts write. “Then, the hidden leverage in pension funds and insurance companies’ portfolios . . . could pose a policy challenge.”

Surprising Fact

The churn of deals in the murky pool of foreign-exchange derivatives approached $5 trillion per day in April—representing two thirds of daily global foreign-exchange turnover overall, the BIS reported Monday.

Key Background

The Fed’s interest rate hikes—and central bank tightening around the world—has triggered steep downturns in the housing and stock markets, and a growing number of experts worry the turmoil could ultimately spark contagion with a large financial market disruption. Policymakers have already been getting concerned about poor liquidity in the Treasury market as yields on the 30-year Treasury leaped up in recent weeks, Bank of America credit strategist Yuri Seliger wrote in a recent note. Additionally, a “precipitous drop in housing prices” has raised financial stability concerns because the housing sector makes up a key part of the U.S. economy, Seliger observed. Turmoil in the foreign-exchange swaps market is yet another potential trigger.