Navigating Global Financial System Fragmentation 2025

aligned blocs. This decoupling scenario would pose a significant threat to the global trading system as it currently exists, with potentially significant costs as a percentage of global GDP .26 From a financial sector perspective, the development of separate technological ecosystems could force multinational financial companies to build costly redundancies to comply with different standards. Similarly, countries might be compelled to align themselves with one of the competing technological standards. Fragmentation also reduces the capacity to share and diversify risks, thereby making the system more vulnerable to shocks.27 The emergence of economic blocs could shift financial flows, making them more regionally concentrated rather than globally integrated. With fewer opportunities for geographic diversification, investors’ portfolios would be limited to certain country blocs and thus more susceptible to shocks. Countries’ reliance on bloc-specific currencies could also “complicate the balancing of global financial flows in the long term”.28 A less robust global financial safety net (GFSN) would heighten the likelihood of financial crises and might necessitate central banks in economies with less- developed capital markets to build up costly liquidity and capital buffers.29 An unstable financial system also increases the risk of price volatility.30 Quantitative assessment of global geoeconomic fragmentation costs To better highlight the risks and costs of a fragmented financial system, this report uses an econometric model to measure the potential macroeconomic impacts of various geoeconomic scenarios. The model measures the impact of geoeconomic fragmentation, broadly (i.e. the impact of fragmentation on the whole economy rather than only the financial system), which includes proxies for financial system fragmentation, specifically, via shocks to productivity, reduced financial flows, etc. The model produces two key findings: –Geoeconomic fragmentation has a consistently negative impact on global output. Analysis in this report suggests that economic output losses could range from $0.6 trillion to $5.7 trillion, or about 5% of global gross domestic product (GDP) in the short term. By comparison, the COVID-19 pandemic caused global output losses of approximately 2.5%. In the long term, as economies and financial actors adjust to deeper fragmentation, output losses could be as high as about 4% of global GDP growth. –Geoeconomic fragmentation is a driver of inflation. Inflation rises steadily in most countries as fragmentation increases. A decoupling of the global financial system and economy into two distinct blocs could increase global inflation by more than 5%. To manage the inflationary shock, countries would potentially need to raise interest rates and institute monetary tightening. This in turn might affect borrowing costs for individuals, corporations and countries. This model shows that the greater the geoeconomic fragmentation, the higher the associated impact on financial system participants. The above estimates describe the potential marginal impact on GDP growth and inflation (i.e. by how much growth and inflation deviate from baseline projections). By evaluating different scenarios, from low fragmentation to very high fragmentation, the model highlights that greater reliance on restrictive economic statecraft policies can lead to a larger decline in global GDP . Model details BOX 2 The analysis employs a multi-country, multisector model that is widely cited and used in academic research. Geoeconomic fragmentation’s economic impact is measured using direct and indirect shocks. Direct shocks refer to trade tariffs, whereas indirect shocks encompass negative productivity changes, a possible consequence of more financial friction. Economic impacts are measured at one year and five years after fragmentation begins (i.e. short and long term) and reflect annualized changes in economic output. This five-year period is chosen because academic research has found that most of the trade adjustments to shocks are completed by year five, and trade elasticity estimates are much more accurate at five years than at 10 years.31 The model observes an import price shock in the short run affecting inflation. A tariff, or financial friction that reduces productivity, can be inflationary by raising the prices of certain imported and domestically produced goods. However, reallocation of production across countries can offset the potential one-time inflationary effect. For example, reallocation of supply chains and financial flows between countries may reduce or inverse an inflationary impact in a particular country if producers are able to substitute away from that country’s domestic producers. The model includes 40 countries, with the remaining financial and production linkages aggregated into a composite “rest of the world” category. Each country is represented by 30 industries, which allows for a nuanced analysis of overall economic output based on individual changes in geoeconomic dynamics. The model considers four scenarios of increasing severity to show how different levels of fragmentation will affect the global financial system and economy. As fragmentation increases across scenarios, the probability of that scenario occurring decreases. For analysis purposes only, the model The emergence of economic blocs could shift financial flows, making them more regionally concentrated rather than globally integrated. 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