Financial and Monetary Systems

The global financial system keeps the world stable and unified. Here's how to strengthen it

Rising geopolitical tensions threaten to fragment the global financial system.

Rising geopolitical tensions threaten to fragment the global financial system. Image: Getty Images/iStockphoto

Daniel Tannebaum
Partner and Global Anti-Financial Crime Practice Leader, Oliver Wyman (Marsh McLennan)
Ole Möhr
Engagement Manager, Oliver Wyman (Marsh McLennan)
This article is part of: World Economic Forum Annual Meeting
  • Rising geopolitical tensions threaten to fragment the global financial system.
  • Economic losses from fragmentation could be as much as 5% of global GDP.
  • The World Economic Forum and Oliver Wyman have developed a proposed framework for strengthening the global financial network.

A well-integrated global financial system is a critical driver of economic growth. Rising geopolitical tensions between countries are increasing the fragmentation of the global financial system and pose risks to global prosperity and human progress.

A new report from the World Economic Forum and Oliver Wyman, Navigating Global Financial System Fragmentation, proposes guidelines that promote global financial integration while respecting countries' domestic policy and national security priorities.

Greater geopolitical uncertainty, caused in part by recent interstate armed conflicts and growing geo-economic competition, consistently ranks as a key risk in surveys of policy-makers and private sector leaders, such as the World Economic Forum's annual Global Risks Report. Both the COVID-19 pandemic and Russia's invasion of Ukraine in 2022 stand out as events that deepened the fragmentation of the global financial system.

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In response to these events, policy-makers face difficult choices in implementing regulatory and institutional reforms that aim to protect the financial system, domestic firms and national security, but may also exacerbate fragmentation. A growing number of countries are adopting industrial policies, such as China's Made in China 2025 and the United States' Inflation Reduction Act, to strengthen the resilience of key pillars of their respective economies. These policies rely on a range of economic statecraft measures, such as investment restrictions or export controls, to achieve objectives in line with countries' national interests.

Amid rising geopolitical tensions in recent years, policy-makers' efforts to redirect flows of capital, goods and services have significantly increased regulatory friction and divergence, creating a more unpredictable environment for investors. This increased uncertainty can reduce cross-border investment and global liquidity, and lead to unintended consequences that can cascade through the global financial system. Should geo-economic competition continue to intensify, economic blocs could emerge with largely separate payment systems, regulations, supply chains and technology ecosystems.

What are the costs of financial system fragmentation?

At the global level, financial fragmentation could reduce global economic productivity and contribute to rising inflation. New research from the economic consulting firm NERA suggests that one-year economic output losses from fragmentation could range from about 0.5% to 5% of global gross domestic product (GDP), depending on the degree of fragmentation. (Though the higher fragmentation scenario – i.e. a 5% global GDP loss – is significantly less likely than a lower one.)

The adverse effects of fragmentation are likely to be unevenly distributed globally; countries or regions with less developed capital markets may bear the brunt. This, in turn, may push smaller emerging market and developing economies (EMDEs) to seek financing outside the conventional international framework, exacerbating fragmentation.

A more fragmented global financial landscape therefore tends to raise the cost of doing business for its participants. In sectors that are more vulnerable to geo-economic fragmentation, firms are moving away from efficient "just-in-time" production strategies, to more resilient but costly "just-in-case" methods to secure their portfolios and supply chains. Geopolitical factors influence private sector decision-making by increasing policy uncertainty and complicating long-term strategic planning.

Companies in regions that are more exposed to geopolitical dynamics could see a negative impact on their corporate credit ratings. Other companies may lose market access to certain countries due to financial sanctions or certain required resources through export controls.

How can governments and financial institutions promote growth in an age of geopolitical competition?

The significant potential risks and costs of financial fragmentation underscore the opportunity to further deepen financial integration and cooperation across the global economy. To seize this opportunity, the World Economic Forum convened a group of senior private-sector leaders from across global financial services to develop, in collaboration with Oliver Wyman, a framework that, if applied, strengthens the global financial system even amid geopolitical realignments.

The result is a set of fundamental guidelines to protect the integrity of the global financial system. Eight principles outline the rules of the road to enable the financial sector to fulfil its fundamental role of facilitating savings, investment and economic growth throughout the global economy:

  • Clearly define and uphold the rule of law to ensure impartial enforcement and predictability across the financial system.
  • Respect financial and physical property ownership rights to maintain trust and encourage investment, thereby fostering financial stability.
  • Avoid unilaterally expropriating sovereign assets even during times of heightened tensions or conflict.
  • Safeguard independence and bolster the capabilities of international institutions, such as standard-setting bodies, to preserve their role in global financial governance.
  • Regulate and manage critical financial market infrastructures, but avoid politicizing or severing the underlying financial rails, given that these systems are essential for maintaining the integrity, functionality and efficiency of the financial system.
  • Ensure that parallel financial market infrastructures are interoperable to facilitate optimal transactions and market efficiency.
  • Structure domestic and multilateral policies and financial regulations to support financial stability and ensure cross-border flows of capital, data, goods, people and ideas.
  • Shield the independence of fiscal and monetary policy to promote financial stability, reduce the risk of competitive interference, and increase opportunities for transparent decision-making.

Eight additional rules put these principles into action by detailing how policy-makers can utilize economic strategies to safeguard national security and sovereignty while promoting global prosperity.

  • Design and implement targeted and well-aligned statecraft measures to minimize the risk of unintended consequences and reduce the private sector’s administrative burden (e.g. carry out cost-benefit analyses, provide clear implementation guidance, and assess and reinforce existing regimes).
  • Establish public-private consultation mechanisms to promote transparency in decision-making regarding the impact of economic statecraft measures on the financial system.
  • Protect populations, sectors, industries and supply chains for humanitarian purposes through exemptions and carve-outs to avoid collateral damage and ensure their continued access to the global financial system.
  • Prioritize the use of economic inducements, including trade agreements compliant with international law, and other financial instruments that foster mutual gain and cooperation over those designed to cause economic pain.
  • Collaborate on areas of geo-economic consensus, including combating financial crime, terrorist financing and the energy transition, recognizing the need for collective action to address these global financial challenges.
  • Promote global financial stability through heightened coordination among major financial powers via transparent data-sharing and inclusive decision-making to minimize negative spillovers and prevent system fragmentation.
  • Reform the global financial system to reflect 21st-century geopolitical and macroeconomic dynamics and provide greater benefits to EMDEs, promoting inclusive economic growth and stability.
  • Protect the ability of firms to engage with actors across the geopolitical spectrum by structuring economic statecraft measures, standards and regulations on a multilateral basis, whenever possible.

These guidelines propose a way to navigate a more multipolar and fragmented world, while preserving the benefits of global financial integration that have driven economic growth for more than half a century.

Safeguarding the interconnected financial system would benefit all its participants. An integrated financial system provides a global safety net to enhance resilience to financial crises, can better harmonize the rapidly changing regulatory landscape to foster trust among stakeholders, and can incorporate new technologies to future-proof the system.

The financial sector is key to mitigating geopolitical tensions by connecting actors across emerging geo-economic blocs. This intermediation can help address shared challenges, such as the energy transition, that require collective action to promote financial stability and continued global economic growth.

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