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By Dr. Gaston Gelos, Deputy Head of Monetary and Economic Department & Head of Financial Stability Policy, Bank for International Settlements (Basel)
The global financial system has undergone a fundamental transformation since the Global Financial Crisis (GFC). One key development has been the shift from lending to the private sector to lending to governments. Another change has been the increasingly central role of certain non-bank financial institutions (NBFIs) in core bond markets. Relatedly, the focus of international financial intermediation has shifted from the activities of global banks engaged in cross-border lending to those of international portfolio investors in global bond markets using sophisticated currency-hedging strategies. These structural shifts have profound implications for how financial conditions spread across borders and entail challenges for central banks, as discussed in the Bank for International Settlements’ (BIS’s) “Annual Economic Report 2025”.
These structural shifts have profound implications for how financial conditions spread across borders and entail challenges for central banks, as discussed in the Bank for International Settlements’ “Annual Economic Report 2025”.
The shift to government borrowing
Since 2008, the composition of global credit has changed dramatically. Before the crisis, credit growth was driven primarily by private-sector borrowing—households taking out mortgages and companies issuing bonds. Banks held these assets directly on their balance sheets, creating a system whereby regulated banking institutions were the central actors.
That has changed. Since the crisis, government debt has become the dominant driver of credit expansion. Persistent fiscal deficits, amplified by COVID-era spending, have caused sovereign-bond markets to expand far faster than corporate-bond markets or bank lending to households. Between 2009 and 2024, government-bond markets grew by roughly 150 percent, while corporate bonds and household loans expanded much more modestly.
Accompanying this shift has been the dramatic growth of non-bank financial institutions. This includes a broad range of diverse players. Between 2009 and 2023, NBFI assets surged from 167 percent to 224 percent of global gross domestic product (GDP), while bank assets grew more modestly from 164 percent to 177 percent. Investment funds and hedge funds have been particularly prominent in this expansion, with private credit funds growing from virtually nothing in the early 2000s to more than $2.5 trillion by 2024.
The globalisation of bond investment
The second major structural change has been the internationalisation of bond markets, particularly government-bond markets. Before 2008, cross-border capital flows were primarily intermediated by global banks making loans. Today, they’re dominated by portfolio investors buying bonds across different countries and currencies.
The numbers are striking. In the U.S. Treasury market—the world’s largest and most important bond market—foreign private-sector holders (mainly NBFIs) have increased their positions rapidly over the past decade, considerably outpacing foreign official holders such as central banks. Private foreign investors now account for more than half of all foreign Treasury holdings. Looking at the major advanced economies collectively, non-bank financial institutions have become the primary foreign private creditors to governments.
The geography of these flows reveals an important insight: They’re driven by gross positions rather than current-account imbalances. Between 2015 and 2023, the largest increase in US bond holdings—around $1.3 trillion—came from European investors. The second-largest increase, $575 billion, came from other advanced economies. Both regions also saw substantial flows in the opposite direction.
This pattern contradicts the traditional view that capital flows largely reflect trade imbalances. Many of the largest cross-border bond investments were derived from advanced economies that weren’t running major current-account surpluses. The largest internationally active asset managers are based in advanced economies and naturally direct their investments toward other large, liquid bond markets in advanced economies.
FX swaps: The plumbing of global finance
What makes this international bond investing possible is the foreign exchange (FX)-swap market—a crucial but often overlooked piece of financial infrastructure. When a European pension fund seeks to invest in U.S. Treasuries, it faces a currency risk: It has euro obligations to beneficiaries but would be holding dollar assets. FX swaps allow the fund to hedge this risk by essentially borrowing dollars against euros, with an agreement to reverse the transaction at a predetermined rate in the future.
These swaps make money “fungible” across currencies. An FX swap is effectively a collateralised borrowing operation, although accounting conventions keep them off balance sheets and don’t classify them as debt. The market is enormous: Outstanding FX swaps reached $111 trillion at the end of 2024, far exceeding both cross-border bank credit ($40 trillion) and international bonds ($29 trillion). About 90 percent have the dollar on one side, and over three-quarters mature in less than a year.
The growth in FX swaps has been particularly rapid among “other financial institutions” (OFIs)—primarily NBFIs—which have nearly tripled their positions since 2009. This expansion directly reflects the growth of international bond investments. Data shows a clear relationship: When foreign holdings of US debt securities increase, so do FX-swap positions in the relevant currencies. The relationship is even stronger when controlling for factors that affect hedging costs, such as interest-rate differentials and yield-curve shapes.
Banks play a pivotal role in this system by facilitating the FX-swap market, though these positions sit off their balance sheets. Without this banking intermediation, the current system of hedged international bond investment couldn’t function at scale.
While FX swaps enable beneficial international portfolio diversification, they also entail risks. The first issue is the lack of visibility. Because accounting standards treat FX swaps as off-balance-sheet items rather than debt, these massive obligations remain largely hidden from view. Another risk stems from the maturity structure of FX swaps. With more than three-quarters maturing in less than a year and the majority within three months, the market requires the constant rolling over of positions. This creates rollover risks: If market conditions deteriorate suddenly, institutions may find themselves unable to renew maturing swaps on acceptable terms, forcing unwanted position closures precisely when markets are already stressed. Importantly, when an FX swap is not rolled over, the dollar-borrowing investor has to come up with the cash dollars to close out the position. This short-maturity profile means that liquidity can evaporate quickly, as institutions discovered during the March 2020 market turmoil when dollar-funding markets seized up.
The use of FX swaps to construct synthetic carry trades introduces another set of vulnerabilities. When investors borrow in a low-rate currency such as the yen and invest in higher-yielding assets elsewhere, they create leveraged, unhedged positions that can unwind rapidly. The August 2024 yen carry-trade episode, while ultimately contained, illustrated how these dynamics can quickly transmit financial stress across borders. Estimating the true size of carry trades remains difficult precisely because the FX-swap positions that enable them are off-balance-sheet.
The procyclicality of FX-swap markets poses macro-level risks. During good times, ample availability of FX swaps at tight spreads encourages greater cross-border investment and risk-taking. But when conditions deteriorate, hedging costs can spike precisely when investors most need to maintain hedges, creating forced selling in underlying asset markets. This amplifies market moves and contributes to the global transmission of financial stress. The Federal Reserve’s (the Fed’s) dollar-swap lines with other central banks—crucial tools during the 2008 crisis and again in 2020—have effectively served as backstops for FX-swap market dysfunction.
Stress can also transmit from domestic markets to the international dollar market: The repo (repurchase agreement) market and the FX-swap market are closely linked. Major dealer banks are the key intermediaries in both of these short-term funding markets. Both repos and FX swaps are forms of collateralised lending, and both count towards the banking sector’s risk budget. Given the increasing presence of hedge funds in core markets, many of which are highly leveraged and reliant on “runnable” short-term repo funding, stress in the repo market could quickly spread to the FX-swap market, potentially causing a global scramble for dollars.
How financial conditions spread across borders
Even outside of stress periods, the new financial architecture has important consequences for how financial conditions are transmitted internationally. The data reveals two key insights.
Even outside of stress periods, the new financial architecture has important consequences for how financial conditions are transmitted internationally. The data reveals two key insights.
First, financial conditions have become significantly more correlated across countries. The co-movement of government bond yields, corporate spreads and equity returns across major economies has increased notably in recent years compared to 2005-19. More sophisticated measures that capture not just contemporaneous correlation but also the transmission of shocks over time show that this connectedness has been rising since the 2008 crisis and recently reached high levels. During the pandemic, more than 60 percent of the variability in the “risk factor” of financial conditions could be explained by cross-country transmissions—higher than during the 2008 crisis itself.
Second, the direction of transmission has evolved. While the United States still exports more financial conditions to other countries than it imports, the gap has narrowed. Other advanced economies increasingly transmit their financial conditions both to the US and to each other.
This mechanism appears to work partly through internationally active NBFIs adjusting their portfolios in response to changing conditions. When these institutions increase their hedged cross-border bond holdings, financial conditions in the destination country tend to ease. The empirical evidence suggests that this transmission operates primarily through the risk factor rather than the level factor, indicating that shifts in global investors’ risk appetites play a key role.
Looking ahead: Challenges and policy responses
These structural changes create both opportunities and challenges. On the one hand, deeper, more liquid and internationally integrated financial markets can improve resource allocation and risk sharing. Foreign investment in government bonds alleviates fiscal deficits and provides portfolio diversification to investors.
On the other hand, the system creates new vulnerabilities, as emphasised in the BIS report (2025). Greater connectedness means that shocks transmit more easily across borders, potentially moving domestic financial conditions away from central banks’ intended stances at times. The prominence of NBFIs, which can adjust portfolios rapidly and sometimes use significant leverage, adds further potential for instability. Swings in risk appetite can now propagate globally through these channels, affecting even the largest advanced economies. And the massive, opaque FX-swap market that enables this system entails risks that are inadequately monitored and understood.
All of this has important implications for policymakers, regulators and supervisors. For one, the increasing influence of external financial factors makes it more challenging to align domestic financial conditions with the intended monetary policy stance. To fulfil their mandates, central banks need to stay attuned to developments in the global financial system and calibrate their actions accordingly. At the same time, liquidity risks in government-bond markets, driven by the increasing presence of highly leveraged hedge funds, could quickly spill over internationally, given the connections between the FX-swap and the repo markets. This underscores the need to apply similar stringency to financial intermediaries posing similar risks to financial stability, regardless of legal form or business model. Examples could include requiring minimum haircuts on all securities-financing transactions and appropriately calibrated margin requirements even for transactions that are not centrally cleared (BIS, 2025).
ABOUT THE AUTHOR
Dr. Gaston Gelos is Deputy Head of the Monetary and Economic Department and Head of Financial Stability at the Bank for International Settlements. In that role, he is also a member of the Bank’s senior management team. He leads analytical work and oversees the work of the secretariats of various committees, including those of the Markets Committee and the CPMI. He also represents the BIS externally in senior groups, including the Basel Committee on Banking Supervision. Previously, he spent 25 years at the International Monetary Fund (IMF), where his last position was Assistant Director and Mission Chief for Mexico. Between 2017 and 2022, he was the Chief of the IMF’s Monetary and Macroprudential Policies Division and before that, Chief of the Global Financial Stability Analysis Division, where he led the thematic work of the IMF’s Global Financial Stability Report. Before that, he held a variety of other positions at the IMF, including as Resident Representative to Argentina and Uruguay. His research includes work on international finance, financial stability, and monetary policy, and has been published in leading academic journals. He holds a Ph.D. in Economics from Yale University and a Diploma from Bonn University. He is a CEPR Research Fellow.