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Don’t always believe a balance sheet 

February 22, 2016

John Kay, Financial Times

Derivative exposures sound alarming until you realise that they’re largely netted out. According to the latest data from the Bank for International Settlements, the central bankers’ central bank, the total amount of outstanding derivative contracts has declined from a 2012 peak of $700tn to about $550tn. To put this into perspective, the figure has fallen from just under three times the value of all the assets in the world to a little over twice the value.

The largest element is interest rate swaps followed by foreign exchange derivatives. Credit default swaps (CDS), the instrument at the heart of the 2008 global financial crisis, are now relatively small — if you can accustom yourself to a world in which $15tn is a small number. It is only slightly less than the US gross domestic product (a little more than $18tn in the final quarter of 2015).

Two banks, JPMorgan and Deutsche Bank, account for about 20 per cent of total global derivatives exposure. Each has more than $50tn potentially at risk. The current market capitalisation of JP Morgan is about $200bn (roughly its book value); that of Deutsche, $23bn (about one third of book value). From one perspective, Deutsche Bank is leveraged 2,000 times. Imagine promising to buy a house for $2,000 with assets of $1.

Before you head for the hills, or the bunker, understand that there is no possibility that these banks could actually lose $50tn. Read more


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