We examine the Interest Rate Swaps Derivatives Beast, the $180 trillion monster that is at the heart of the entire collapse of our financial systems.Here is some of the raw data used in my presentation:
Being OTC instruments interest rate swaps can come in a huge number of varieties and can be structured to meet the specific needs of the counterparties. By far the most common are fixed-for-fixed, fixed-for-floating or floating-for-floating. The legs of the swap can be in the same currency or in different currencies. (A single-currency fixed-for-fixed rate swap is generally not possible; since the entire cash-flow stream can be predicted at the outset there would be no reason to maintain a swap contract as the two parties could just settle for the difference between the present values of the two fixed streams; the only exceptions would be where the notional amount on one leg is uncertain or other esoteric uncertainty is introduced).
1995 report Office Comptroller of the Currency http://www.occ.treas.gov/ftp/deriv/dq298.pdf
The notional amount of derivatives in commercial bank portfolios decreased by $778 billion in the fourth quarter to $16.86 trillion. (This figure excludes spot foreign exchange contracts, which decreased by $299 billion to $305 billion as of December 31, 1995.) Although notional amounts have increased steadily over the last few years, this quarter’s slight decline is consistent with a pattern of stabilizing or declining notional amounts that have been present in previous fourth quarter numbers.
During the fourth quarter, the notional amount of interest rate contracts fell by $234 billion, to $11.10 trillion. Foreign exchange contracts fell by $555 billion, to $5.39 trillion, while commodity and equity contracts grew by $12 billion, to $378 billion. The number of commercial banks holding derivatives decreased by 37 in the fourth quarter to 558. [See Tables 1, 2, and 3.]
Off-balance sheet derivatives are concentrated in the largest banks. Nine commercial banks account for 94 percent of the total notional amount of derivatives in the banking system, with 9 percent accounted for by the top 25 banks (these figures include spot foreign exchange). For the years 1991 through 1994, the concentration of derivatives in the top nine banks was 86 percent, 91 percent, 91 percent, and 92 percent respectively. [See Table 3 for concentrations excluding spot foreign exchange.]
Approximately 66 percent of the notional amount of derivative positions were comprised of interest rate contracts with an additional 32 percent represented by foreign exchange contracts. Commodity and equity contracts were only 2 percent of the total notional amount. The composition of contract types remains relatively unchanged since 1991. [See Table 3.]
Over-the-counter (OTC) and exchange-traded contracts comprised 86 percent and 14 percent, respectively, of the notional holdings as of fourth quarter, which is virtually the same as third quarter. OTC contracts tend to be more popular with banks and bank customers due to the flexibility in tailoring them to meet risk management needs. However, OTC contracts tend to be less liquid than exchange-traded contracts, which are standardized and fungible. [See Table 3.]
The notional values of short-term contracts (i.e., with remaining maturities of less than one year) are down $829 billion, or 9.1 percent from third quarter, to $8.27 trillion. Medium-term contracts (i.e., remaining maturities of one to five years) increased by $53 billion, or 1.5 percent, to $3.59 trillion, and long-term contracts (i.e., maturities of five or more years) increased by $62 billion, or 7.6 percent, to $876 billion. [See Tables 10, 11, and 12.]
In 1990, interest rate derivatives were less than $4 trillion. By 1998, it was almost $24 trillion.
The 2004 survey took place during a period of heightened interest in foreign exchange as a separate asset class. A return to steadier trends and higher volatility led to increased volumes largely due to momentum trading by investors. In addition, a widening of interest rate differentials encouraged growth in the so-called “carry trade,” where investors finance positions in high yielding currencies by borrowing in low yielding currencies. The growth in the number and variety of electronic trading alternatives available to market participants also contributed to the increase in reported turnover as they reduced trading costs and other barriers to entry while enhancing pricing transparency. This in turn led to an increase in the number of leveraged accounts, commodity trading advisors (CTAs), and currency overlay managers focusing on foreign exchange as an asset class, many of which regularly engage in high volume programmed and algorithmic trading strategies.
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