financial crises and encounter greater difficulty achieving sovereign debt relief.41 In an environment with more and fragmentated creditors, individual creditors might engage in bilateral rather than multilateral negotiations with debtor nations, further complicating the resolution process. As geopolitical tensions escalate, the likelihood of a sudden stop in capital flows increases.42 In a system with diminished liquidity, states without robust and well-integrated capital markets may encounter difficulties in securing funding for essential investments, partly due to reduced access to private capital. This includes EMDEs as well as developed regions with fragmented capital markets. The EU’s lack of integrated capital markets, as recently highlighted in the Draghi Report, represents a significant hurdle for unlocking more economic dynamism in Europe.43 Current trends indicate that amid rising geoeconomic uncertainty, more investors are directing their capital to advanced economies, especially the United States.44 In addition, some governments’ extraterritorial enforcement of regulations have imposed requirements stricter than local laws, which increases compliance and operating costs for global financial institutions operating abroad. These heightened costs may compel international banks to withdraw from EMDEs, leading to increased financial intermediation costs and diminished financial inclusion in those regions. Further financial system decoupling would increase the risk of countries and firms getting caught between economic blocs with conflicting regulations and standards. Fragmentation might also impede multilateral collaboration on challenges where collective action is essential, such as the energy transition and EMDE debt relief. The report’s quantitative analysis shows that non-aligned countries would likely suffer the highest negative costs, as they are forced to choose one bloc as a trading partner and are impeded in accessing advanced technology and research and development.45 Further financial system decoupling would increase the risk of countries and firms getting caught between economic blocs with conflicting regulations and standards. Navigating Global Financial System Fragmentation 21

Navigating Global Financial System Fragmentation 2025