INTERNATIONAL: The growing fragmentation in global financial systems poses a serious threat to international banking profits, lending, and economic growth, according to a recent report by Swift and Economist Impact featured in the Asian Banking and Finance press release. This phenomenon, a reduction in international financial integration and disruption of cross-border payments, investments, and credit flows, could have dire consequences for the global economy.

The report highlights that financial fragmentation could result in nearly 280 million fewer jobs and a 6% reduction in global GDP.

Geopolitical tensions and financial instability

Financial fragmentation has become an increasing concern in recent years, driven by geopolitical tensions, geoeconomic fragmentation, and the rise of technological decoupling. As governments worldwide adopt more inward-looking policies, the risk of economic instability intensifies. Swift argues that this trend deepens global divides and leads to significant economic repercussions, making the world poorer in the process.

For banks, financial fragmentation raises the risk of financial instability, primarily by increasing funding costs, lowering profitability, and suppressing lending. The inability to smoothly transfer assets and capital across borders amplifies these risks, potentially leading to more significant economic downturns. Additionally, this fragmentation threatens progress in financial inclusion, reinforcing the divide between the “haves” and the “have-nots.”

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Digitalization’s dual role in global finance

Digitalization has the potential to either enhance or hinder global financial interconnectivity. While digital platforms can enable faster and more efficient transactions, they often struggle with interoperability across countries, leading to fragmented financial systems. These “walled gardens” limit foreign participation and exacerbate the risks posed by financial fragmentation.

Though gaining popularity as alternative methods of cross-border finance, cryptocurrencies further complicate the situation, creating fraud and misconduct risks while increasing friction between incompatible platforms.

However, developing Central Bank Digital Currencies (CBDCs) could offer a promising solution. By establishing a digital public infrastructure (DPI), CBDCs could help harmonize digital financial transactions, thus reducing fragmentation. According to the United Nations, adopting DPI in financial services could boost global GDP by $200 billion to $280 billion by 2030, equivalent to 1% to 1.4% growth.

This potential underscores the importance of embracing digital financial solutions while ensuring standardization and cross-border cooperation.