The global financial system refers to the worldwide framework of institutions, financial markets, and financial infrastructure that enable international flows of capital for investment and trade financing. In 2023, the global financial system continues to undergo major changes as new technologies, economic powers, and regulatory approaches reshape global finance.
Introduction
The global financial system is in a period of transition. While the US dollar remains the world’s primary reserve and trading currency, China’s renminbi is steadily increasing in usage. Developing countries continue working to expand financial inclusion for the nearly 2 billion unbanked adults. Cryptocurrencies and decentralized finance (DeFi) are disrupting traditional banking and creating new digital asset classes. Climate change is forcing financial institutions to prioritize sustainable investing.
At the same time, the Covid-19 pandemic has accelerated digitalization across banking and financial services. Financial regulations continue to tighten after the 2008 financial crisis, with a focus on reducing systemic risks. New financial technologies are enabling more secure, efficient cross-border payments and 24/7 trading. This article examines the key aspects defining today’s global financial system.
The US Dollar’s Continued Dominance
The US dollar remains the most widely held international reserve currency, used for nearly 90% of global foreign exchange transactions. As the world’s largest economy with deep capital markets, most commodities like oil and gold are priced in dollars. The dollar’s dominance gives the US economic advantages, including cheaper borrowing costs and minimal exchange rate risk.
However, the dollar’s share of global foreign exchange reserves has gradually fallen from over 70% in 2000 to around 59% today as other currencies play bigger roles. The euro is the second most held reserve currency, comprising around 20% of allocated reserves. Meanwhile, China’s push to internationalize the renminbi has seen it account for just over 2% of reserves.
The Rise of the Renminbi
China is taking concerted steps to elevate the global status of its currency, ranging from currency swap agreements to opening onshore capital markets. The renminbi is now the fifth most active currency for global payments by value. To accelerate renminbi internationalization, China has established offshore clearing banks and trading hubs across Asia and Europe.
More foreign central banks and institutional investors now hold renminbi assets. Major commodities like iron ore and crude oil now have renminbi-denominated price benchmarks. However, full convertibility and market-set exchange rates are needed for broader adoption. China faces a difficult balancing act in liberalizing capital controls without destabilizing its economy.
Growing Influence of Developing Countries
Developing and emerging economies now account for over 75% of global growth in GDP and trade as advanced economies slow. Countries like India, Brazil, and Indonesia are forming their own multilateral institutions outside traditionally Western-dominated organizations.
For example, the New Development Bank and Asian Infrastructure Investment Bank focus on sustainable infrastructure financing in emerging economies. Such institutions expand developing countries’ influence in global economic governance to better serve their interests and priorities.
The Push for Financial Inclusion
Over 1.7 billion adults globally lack access to formal financial services and credit—excluded from basic bank accounts, payments, insurance, and investment opportunities. Financial inclusion is recognized as critical for reducing poverty and inequality. India’s biometrically verified national identity system, Aadhaar, has helped over 80% of adults obtain bank accounts. Sub-Saharan Africa is leapfrogging to mobile money platforms for the underbanked.
Governments are introducing reforms like relaxing Know-Your-Customer norms, allowing agent banking, and providing subsidized basic accounts. Digital financial services via mobile phones are key to drive financial inclusion. Public-private partnerships with fintechs also help expand access through innovative business models.
Growing Adoption of Digital Currencies
Cryptocurrencies like Bitcoin and Ethereum are gaining more mainstream traction for cross-border payments and as speculative investments. Central bank digital currencies (CBDCs) are the digital form of fiat money—the Bahamas was first to launch a CBDC called the Sand Dollar.
Over 86% of central banks are now exploring CBDCs. Leading examples include China’s eCNY and the Eastern Caribbean Central Bank’s DCash. CBDCs enable more affordable remittances, conveniently digitized government transfers, and 24/7 real-time payments. However, risks around financial stability, data privacy, and monetary policy control need addressing.
Private stablecoins like Tether peg their value to fiat currencies, aiming to mitigate cryptocurrency volatility. However, stablecoins face regulatory scrutiny—the USD Coin is the highest market cap compliant stablecoin. The crypto market exceeded $3 trillion in November 2021 before declining, indicating growing but fluctuating adoption.
Decentralized Finance’s Disruptive Potential
Decentralized finance or DeFi refers to blockchain-based financial services without intermediaries. DeFi applications allow peer-to-peer lending and borrowing, trading, insurance, savings, derivatives, and more. The total value locked in DeFi grew from $700 million in January 2020 to over $250 billion in November 2021, highlighting surging investor appetite.
Key DeFi advantages include 24/7 operations, global accessibility, transparency, and automation via smart contracts. DeFi could expand access and efficiency in payments, credit, and asset management for the underserved. But vulnerabilities around volatility, cybersecurity, governance, and compliance will constrain mainstream DeFi adoption in the near term.
Stricter Financial Regulations
Regulations on banks and other financial institutions have tightened significantly since the 2008 global financial crisis (GFC) exposed system-wide risks. Stricter capital and liquidity requirements now limit excessive risk-taking by banks under Basel III norms. “Bail-in” policies allow write-downs of bank creditors and bondholders to share losses.
New entities like the Financial Stability Oversight Council (FSOC) monitor stability risks, while central clearing mandates improve derivatives transparency. The volume and complexity of regulations have increased compliance costs for financial institutions. However, regulations have also enhanced supervision and made the financial system safer overall.
Green Finance and Sustainable Investing
Climate change is catalyzing the growth of green finance focused on environmental sustainability. Central banks and regulators are introducing taxonomies, disclosure standards, and stress testing around climate risks and carbon emissions. Green bonds hit a new high of $290 billion issued in 2020.
Asset managers are launching more sustainability-focused investment funds, buoyed by rising consumer demand. Many institutional investors have signed up to the Net Zero Asset Managers initiative, committing to achieve net zero emissions by 2050 or sooner across their investments. Transitioning the global financial system to support green sectors could require over $100 trillion by 2050 according to some estimates.
The Accelerating Digitalization of Finance
The Covid-19 pandemic accelerated the adoption of financial technologies or fintech. Digital payments saw dramatic increases in volume. For example, contactless card payments jumped 40% in 2020 globally. E-commerce also surged, with online sales as a percentage of total retail jumping from 14% in 2019 to over 17% in 2020.
In wealth management, digital-first firms referred to as “robo-advisors” attracted record net new assets in 2020. Challenger banks offering mobile-first services continued taking market share from incumbents. Fintech collaboration via embedded finance also grew—technology firms incorporating financial services APIs into their platforms and products. The pandemic has led digital to become the undisputed default across financial services.
The Changing Payments Landscape
Payment systems are modernizing across countries both for retail and wholesale cross-border transfers. Instant payment systems enabling funds transfer under 10 seconds are now live across major economies including the FedNow service in the US. Cryptocurrency usage for payments is also rising—crypto-based remittances can lower costs and improve speed.
Open banking regulations in the UK, EU, and elsewhere are driving payments innovation and competition. They allow consumers and businesses to directly share bank data with trusted third-party providers via APIs to access value-added services. Real-time payments reduce settlement risks and allow innovative business models. They are helping power the platform economy’s embedded payment capabilities.
Ongoing Consolidation in Banking
Cost and revenue pressures plus digital competition are driving consolidation across banking globally. In the US, merger activity has created a market dominated by a few mega banks, with the largest 6 holding over 70% of total industry assets. Regional banks are also merging to gain scale and geographic reach.
In Europe, negative interest rates have hurt bank profitability, leading to high-profile mergers like the CaixaBank-Bankia union in Spain. Pan-European banks are retreating to their home markets amidst Brexit uncertainty and digital disruptors. Asian regulators have discouraged domestic consolidation, but Japanese megabanks are merging overseas operations in Southeast Asia. Consolidation is improving cost efficiency, but risks reducing competition.
The Continued Growth of Shadow Banking
Shadow banks provide credit through financial activities outside traditional banking. This includes investment funds, money market funds, insurance companies, and fintech lenders. Global shadow banking assets grew from $28 trillion in 2002 to exceed $190 trillion in 2020, demonstrating massive expansion.
However, post-2008 reforms better regulate various shadow banking entities as system-wide risks emerge from opaque interconnected linkages. Securitization markets remain a regulatory focus area. Ongoing oversight is critical as innovation keeps blurring old boundaries between regulated banking and shadow banking activities.
Ongoing Risks and Challenges
While regulations have strengthened the financial system, structural vulnerabilities remain that could trigger new crises. Soaring sovereign and corporate debt levels since COVID-19 limit future policy responses. Profitability pressures on banks may encourage excessive risk-taking. Over $15 trillion of government bonds still have negative yields, distorting valuations.
Trade and geopolitical tensions could heighten volatility across capital flows, currencies, and commodities. Cyber risks are growing, evident in the 2021 compromise of the Swift financial messaging network. Climate change poses systemic risks that need better incorporation in financial stability monitoring frameworks. As regulations evolve, balancing innovation, inclusion, integrity, and stability remains an ongoing challenge.
Conclusion
In conclusion, the global financial system is undergoing sweeping yet uneven changes as we move towards 2030. While still dominant, the US dollar faces growing multicurrency competition. Developing countries are wielding greater influence through new institutions. Expanding access and managing risks are both crucial priorities. New technologies can enhance efficiency, inclusion, and sustainability if harnessed judiciously. Overall, proactive reforms and balanced regulations are key to creating a more resilient, equitable, and dynamic global financial system this decade.
