Here is the perfect opportunity to clarify a misconception.<p>Swaps != debt.<p>Swaps do not create a liability&#x2F;asset <i>unless interest rates move</i>, and even so, most of the swap contracts will then nullify one another.<p>Most banks admittedly have trillions of notional swaps on their books. The very vast majority of these offset each other. The &quot;open position&quot; (net exposure) in banks is very heavily monitored by the authorities. Banks are not heavily exposed.<p>Arguably, corporates (who hedge) and insurance companies or pension funds DO have open positions in swaps. But even so, recall that the potential liability is proportional to the likelihood of an interest rate move. Let&#x27;s say an open position of 1 trillion (enormous) receiver swaps (lent) sees a 3% upmove in 5y interest rates on an average 5y maturity of the book (usually lower). Assuming rates near zero which they are, the duration calculation means a net debt becomes payable by such company of 3x5% = 15% of the notional = 150 billion USD. So 1 trillion became 150 billion, even under an extreme scenario. 1&#x2F;6th. Then recall, that rates will never move 3% (300bps) in one line. They&#x27;ll move a few bps every day. It&#x27;ll be very clear once the liability hits, say 5-10 billion, that the counterparty cannot pay anymore, they will be made bankrupt (or close these positions) well before 3% (remember daily margining?), and the swap contracts will become null and void immediately. So now 1 trillion of swap contracts became 5-10 billion realizable debts.<p>By contrast, when the Treasury borrows 1 trillion, they owe a full trillion, no matter what happens in interest rates. See the difference?<p>Now in this analysis, I&#x27;m glossing over counterparty risk in swaps. Banks &quot;not heavily exposed&quot; relies on the idea that all banks are good for their commitments, since their netting is done against other banks. This is not the case in a Lehman style scenario(it&#x27;s like a huge web that even neo4j would have trouble monitoring - ha ha - if a piece of the web falls away, many banks are then potentially exposed). Hence the major focus of all policy makers in the past several years has been to make derivative clearing daily-marginable, and exchange cleared. To erase that problem (outside of 6-sigma &quot;impossible&quot; etc - see one of my other posts)<p>Further to that policy maker regulation, did you know that in the latest European banking sector rules, derivative contract commitments are senior <i>even to small depositors</i>? So equity goes first, then subordinated (higher yield) debt, then depositors &gt; 100k, then senior debt, then depositors &lt; 100k, and <i>only then</i>, swap liabilities.<p>Of course, lawyers sit even above swaps ;-)