A table with the total of the notional derivatives that American banks ordered from more to less is appearing on social media. Those who share use it to say that, adding the total to an absurd amount (a thousand trillion dollars), the economy is about to explode. This is not true, it just shows ignorance of how the global financial system really works.
Let's start because the number of derivatives that each bank has is not a secret, but well known to the authorities. Furthermore, the way to value it (adding the notional) does not say much, as it is just one of the factors used to calculate the payments associated with the financial derivative.
The notional of the derivatives that each bank has is no secret
Since the 2008 financial crisis, banks have had to report their positions to “transaction repositories” or trade repositories. Here you can consult a list of those accepted by ESMA, the European financial authority.
Specifically, this table round by networks Social I'm sure it comes from public reports given by the entities themselves, which can be found with a simple Google search, in other words, it's a Very easy information to obtain, none of the Twitter accounts where you could see obtained confidential information.
The notional of derivatives is nothing more than the reference quantity over which the value of the derivative is calculated. Let's think about life insurance, the insured value is what will be given to the beneficiaries in the event of the death of the insured, but if the insurance company has a thousand customers insured for one million euros, it does not mean that it owes one billion euros to the beneficiaries, but you You will win or lose depending on how well you calculated your prizes. Something similar happens with derivatives. It is a reference value, but it does not mean that they are a debt.
Before we said that knowing the meaning of the operation is not enough information to know its risk. Returning to the example of life insurance, compensation of one million euros does not tell us much about the risk of an insurance policy. Insuring a 20-year-old woman who plays sports in moderation is much less risky than insuring a 70-year-old man who has been a smoker since he was 15. Even if the compensation is the same. The same thing happens with financial derivatives, there are many other factors to consider.
Furthermore, a common practice is that Derivatives are contracted “hedged”, that is, covered. What this means? That if a “trader” at a bank contracts a derivative, it is with the intention of covering a position he already has (perhaps in other investments such as interest rate or mortgage derivative) or of covering this position in the future. In other words, if you have a derivative that makes you pay flows of one thousand euros per month, you will try to obtain others that make you receive equivalent flows (for example, eight installments of one hundred and one of two hundred) and take a commission on the difference.
There are limits to the derivatives a bank can have and mechanisms to reduce its risk
This table shows something that is quite expected, the bigger a bank is, the more derivatives it has. This is normal, as a bank's hiring capacity is, by common sense and more importantly, regulatory limited by the capital it has. The larger the financial services company, that is, the more capital shareholders have in it, the more contracting capacity (derivatives, mortgages, personal loans, etc.) they will have.
But this is not the only mechanism that limits each trader's ability to hire. Banks have risk departments specialized in controlling that open positions do not get out of control. If a trader trades too much or their trades have too much risk, they will be blocked from trading by the investment company's risk department. We won't go into how the corresponding banking departments calculate risks, but we monitor various types of risks and they are regulated as they should be (they are quite sophisticated methods).
Furthermore, for If these internal mechanisms are insufficient, there are other mechanisms to reduce the risk of the position that a financial agent may have. The first is central counterparty clearing houses. They existed before the fall of Lehman Brothers, but since then more efforts have been made by legislators (in Europe, the USA and Japan) so that a greater percentage of operations go through this type of service. In short, clearinghouses ensure that if one of the counterparties is unable to fulfill its obligations, they will do so. To do this, they require collateral from both counterparties and have large resources waiting to be used if the counterparty's collateral is insufficient.
The other mechanism is for operations that do not go through cameras, this is collateralized. This means that financial services companies cover this operation with their counterparties, providing guarantees that can be executed if one of the two defaults. In other words, in the event of one of the chains failing, it had to provide guarantees covering all or a large part of its position. It's a bit like when a bank asks us for a house as collateral to foreclose in case we don't pay the mortgage or a pawnshop asks us for a gold ring to lend us money. So let's not think about dominoes, there are “buffers” between one piece and another, which means that if one falls, the others don't.
We can discuss whether these mechanisms (internal and external) are sufficient and adequate, whether the risk is well covered or not. But we cannot add the notional of the derivatives and say “it is a very large quantity, it is a bubble”, just as we wouldn't think that all car insurance companies are about to go out of business because there are so many cars parked on the street.
So the next time you see someone argue that the global financial system is a bunch of dominoes waiting to fall using the sum of all the derivatives in the financial system as an argument, laugh in their face. It doesn't matter what degrees or certifications you claim to have, it just shows your ignorance.
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