Navigating Global Financial System Fragmentation 2025

2What are the costs of a fragmented financial system? A fragmented global financial system can negatively affect GDP and increase inflation, particularly for EMDEs. Policy-makers can help drive economic growth through deepened financial integration. From a macroeconomic perspective, the potential risks and costs of geoeconomic fragmentation are substantial. This report estimates that the global costs of fragmentation could amount to approximately $5.7 trillion or about 5% of current global GDP . A more fragmented global order will in most instances act as a cost driver. In industries with higher exposure to geoeconomic fragmentation, firms have shifted from “just-in-time” production models to costlier “just-in-case” approaches that diversify portfolios and supply chains. Such measures can increase resilience but also increase costs. Investment restrictions, export controls and tariffs can result in inefficient reorganizations of portfolios and supply chains, increasing global inflation. One illustrative example is a US government rule from October 2024 limiting investment in Chinese high-tech sectors.23 Another is the Chinese government’s export restrictions on rare earth metals and minerals, which are essential to produce high- tech products, including semiconductors and lithium batteries.24 While these measures may be designed to protect respective national security interests, they can increase costs for consumers and businesses. Geopolitical pressures can also reduce liquidity throughout the financial system, as nations erect new barriers to foreign exchange markets, cross- border transactions and investment flows. IMF research indicates that a significant increase in geopolitical tensions between two countries can “reduce bilateral cross-border portfolio and bank allocation by about 15%”.252.1 Macroeconomic impact Business mitigation strategies: Consider broader risk analysis Incorporating geoeconomic factors into their non-financial risk assessments allows financial institutions to identify and assess a broader range of risks, enhancing their overall risk management framework. Regulatory divergence, another potential consequence of geoeconomic fragmentation, can also raise compliance costs for the public and private sector. Growing geopolitical divides make it more difficult for financial governance institutions to share data, improve transparency, harmonize regulations and build trust. Such divergence can drive the growth of parallel but incompatible financial market infrastructures (FMIs), which increases costs and complexity. As geoeconomic competition intensifies, increasing regulatory divergence can lead to the emergence of economic blocs with largely separate payment systems, regulations, supply chains and technology ecosystems. A major risk to the financial system arises less from the intended policy objectives than from the unintended consequences of policy-driven fragmentation. Recent history presents examples of policy-makers electing to accept fragmentation to advance other goals, such as preventing systemic contagion or insulating supply chains from COVID-19 shocks. Such policies may result in small efficiency losses that policy-makers deem acceptable to ensure the supply of certain critical goods. However, an unintended consequence of these measures may be a tendency for countries to reorient international trade to focus on geopolitically Potential reduction in bilateral cross-border portfolio and bank allocation due to an increase in geopolitical tensions (IMF). Navigating Global Financial System Fragmentation 16