Financial fragmentation threatens bank profits and lending

Globally, it can lead to nearly 280 million fewer jobs by 2030.

Financial fragmentation may lead to lower bank profits and depressed lending, warned Swift and the Economist Impact.

Defined as a reduction in international financial integration and the disruption of cross-border payments, credit and investment that ultimately reduces cross-border capital flows, financial fragmentation can lead to as much as nearly 280 million fewer jobs and a global GDP lower by 6%, the report warned.

The risk has risen in recent years with the onslaught of geopolitical tensions, geoeconomic fragmentation, and technological decoupling.

“Around the world, governments are turning inward, a trend that comes with troubling economic risks and consequences. Not only does it lead to a more fractured world, it also makes the world poorer, according to Swift.

For banks, fragmentation raises the risk of financial instability by increasing funding costs, reducing bank profitability and depressing lending.

Without the ability to seamlessly transfer assets and capital, these risks could compound and flare up. Fragmentation can also set back financial inclusion, advancing a world of ‘haves and have nots’, the report further warned.

“Fragmentation harms cross-border capital flows, such as foreign direct investment (FDI), which support consumption, investment financing, risk diversification and resource allocation,” the report said.

Digitalisation can serve as a bane or boon for interconnectivity.

Digital systems are often inoperable between countries, leading to “walled gardens” that exclude foreign participation.

Alternative methods of cross-border finance such as cryptocurrencies flourish in digital channels, but deepen risk of fraud and bad behavior. It also creates additional friction when such methods are not compatible with one another.

“[If financial services] develop without standardisation or harmonisation across different digital platforms, then digitised financial transactions will be similarly fragmented,” saud Cyn-Young Park, director, regional cooperation and integration and trade division, Asian Development Bank.

On the other hand, central bank digital currencies (CBDCs) represent a potential manifestation of digital public infrastructure (DPI).

The United Nations (DPI) estimates that DPI in financial services could boost the GDP by an average of $200b to $280b, equivalent to a growth of 1% to 1.4% of GDP levels by 2030.