The Bank for International Settlements (BIS) has issued a stark warning about the fragility of the modern global financial system, emphasizing that despite significant changes since the 2007–09 financial crisis, the core dynamic of borrowing short, investing long, and leveraging up remains firmly in place. As reported by the Financial Times, the BIS’s latest Annual Economic Report highlights a system increasingly dependent on short-term, opaque funding mechanisms—particularly in US dollars—and heavily reliant on central banks as backstops in times of crisis.
While traditional banks once dominated the landscape, today’s financial system is driven by non-bank financial intermediaries such as hedge funds, pension funds, and insurance companies. These institutions, BIS economic adviser Hyun Song Shin notes, are now more interconnected than ever, even as global economies grow more fragmented.
“The monetary and financial system is now more tightly connected than ever,” Shin observed, describing a financial architecture that resembles “an accident waiting to happen.”
A key shift since the global financial crisis (GFC) is the explosion of cross-border credit, particularly in the form of bond holdings between advanced economies—most notably the US and Europe. The BIS stresses that gross, not net, positions are the real driver of financial instability, as they reflect highly leveraged positions and rapid shifts in investor sentiment.
One of the report’s most striking findings is the staggering size and opacity of the foreign exchange (forex) swap market, which the BIS says reached $111 trillion at the end of 2024—far surpassing cross-border bank claims ($40 trillion) and international bonds ($29 trillion). These swaps are primarily used by foreign investors purchasing US Treasuries, who hedge their dollar exposure through short-term contracts that do not appear on balance sheets.
Nearly 90% of these swaps involve the US dollar, and more than three-quarters mature in less than a year, raising concerns about liquidity mismatches and rollover risks. Hedge funds, which receive the bulk of their financing via repo markets, often face little oversight—over 70% of bilateral repo financing comes with zero haircut, meaning lenders have limited control over the leverage being deployed.
“This system has much of the fragility of traditional banking,” the BIS warned, “but even less transparency.”
The report also highlights how financial conditions in one market can quickly ripple across borders. For example, large foreign holdings of US bonds mean that monetary shifts in Europe or Asia can influence US financial conditions—and vice versa. Currency fluctuations affecting dollar-denominated debt in emerging markets can trigger sudden revaluations in domestic asset prices.
In past crises, such as the GFC and the COVID-19 pandemic, the Federal Reserve played a critical role as the global lender of last resort, supplying liquidity both directly and through swap lines with other central banks. The BIS suggests a similar response may again be necessary in future turmoil. But it cautions that this assumption—particularly with Fed Chair Jay Powell set to depart next year—may not be guaranteed.
Ultimately, the BIS presents a sobering assessment: the financial system’s increasing reliance on short-term, dollar-based funding and unregulated institutions could leave it vulnerable to sudden shocks. Effective crisis management will depend on central banks’ ability—and willingness—to intervene swiftly and cooperatively.
As reported by the Financial Times, the BIS’s analysis underscores the need for vigilance and reform in a financial environment that appears stable on the surface but carries deep structural vulnerabilities beneath.
