Why the global financial landscape is undergoing a seismic shift

Regulators are struggling to keep up with fintech’s rapid growth and the impact of big data, even as intense geopolitical rivalries mean accidents could easily escalate into crises

Andrew Sheng

Published: 10:00pm, 16 Jul, 2021

Why you can trust SCMP

August 15 this year marks the 50th anniversary of US President Richard Nixon delinking the US dollar from gold. Instead of a crisis, the ensuing half-century marked the pre-eminence of the US financial system.

In 2017, then US Treasury secretary Steven Mnuchin commissioned four major studies on the US financial system that reviewed its efficiency, resilience, innovation and regulation. These surveys highlighted US dominance in all four areas of banking, capital markets, asset management and financial technology.

The reports proclaimed the US banking system “the strongest in the world”. Its capital markets were deemed “the largest, deepest, and most vibrant in the world”. According to the reports, “nine of the top 10 largest global asset managers are headquartered in country” and, in fintech, “US firms accounted for nearly half of the $117 billion in cumulative global investments from 2010 to 2017”.

Underpinning the US financial system’s success is the US dollar’s dominant currency pricing role. The dollar accounted for 88 per cent in paired foreign exchange currency trading in 2019 and 59 per cent of official foreign exchange holdings in 2020.

As an IMF study has shown, this pricing role affects emerging market economy exchange rate policies, as devaluation of their currencies would have only limited positive impact on their exports, but amplifies their import contraction.

Furthermore, because emergent market debt is largely denominated in dollars, any dollar appreciation would cause a contraction in emerging market liquidity and growth. This is why US interest rate increases are feared by emerging markets.

Several factors have combined to create the recent seismic shift in the global financial landscape. First, fintech has eroded the banking system’s dominance. The Financial Stability Board 2020 report on nonbank financial institutions (NBFI) revealed that as of end-2019, they accounted for 49.5 per cent of global financial assets of US$404 trillion, compared with 38.5 per cent for the banks.

Chinese lifestyle platform puts US IPO on hold amid Beijing crackdown

Second, fintech has enabled new arrivals in the financial sector, including big tech platforms that use big data, artificial intelligence, apps and cloud computing to provide more convenient, speedy and customer-oriented finance.

This month, a major BIS study on the implications of fintech and digitisation on financial market structure showed how big tech has muscled its way into traditional banking, especially in payment services, lending and asset management.

Given the combined growth of NBFIs and big tech, traditional bank regulators find they regulate less of the financial system, although central banks are still responsible for overall financial stability.

Third, intense geopolitical rivalry is a further minefield in the financial landscape. If global supply chains and technology standards are going to decouple, how should finance respond? As the US applies pressure on Chinese companies and individuals through sanctions and legislation, financial institutions are struggling to deal with shifting goalposts.

A woman and a child walk past the People’s Bank of China building in Beijing on March 4. China’s central bank, like others around the world, is grappling with how to regulate the fintech industry. Photo: Bloomberg

The Ant Group and Didi Chuxing events are a reflection of regulatory concerns over whether large domestic big data platforms should be subject to foreign legislation with national security implications. Will India, for example, continue to allow foreign big tech firms to own all their client data?

Fourth, the regulatory trend towards “open financial data” in which banks open up their client databases to allow new players to access customer accounts and data will provide new products and services. But this also raises concerns about client privacy and data security.

No country has yet figured out how to manage competition fairly in the fintech world when five firms – Amazon, Microsoft, Google, Alibaba and IBM – dominate 70 per cent of cloud-related infrastructure services.

Alibaba owns the South China Morning Post.

Fifth, blockchain technology, cryptocurrencies and central bank digital currencies are now increasingly coming on stream, making possible payments and transactions that rely less on official currencies and also outside the purview of regulation.

In short, the official regulators are responsible for system stability, but may not have access to what is really going on in the blockchain space. That is an accident waiting to happen.

04:35

Blockchain in Asia: China Bets on Blockchain

All these suggest that the global financial system has grown faster and is too complex and entangled for any single nation to manage on its own. If the largest financial systems are caught up in acrimonious geopolitical rivalry, what are the risks of financial accidents that can easily escalate into financial crises?

In the 2008 global financial crisis, the Group of 20 stood together to execute a range of responses. This time around, there is no unity as the US continues to apply financial sanctions against its rivals – 4,283 cases as of January 2021, of which 246 and eight respectively were against mainland Chinese and Hong Kong entities.

The bubble in fintech valuation that has fuelled stock markets and investments in technology is fundamentally driven by central bank loose monetary policy.

Central bank assets have grown faster – at 8.4 per cent per annum on average in 2013-2018 – than banks (3.8 per cent) or NBFIs (5.9 per cent) to corner 7.5 per cent of global financial assets. Can financial markets assume that central banks will continue to underwrite their prosperity?

As inflation rears its head, central banks will have to reverse their loose monetary stance, putting the global financial system under stress. This system has structural and regulatory cracks, but they can only be fixed through some political understanding among the big players. Without this, expect a messy outcome.

Andrew Sheng writes on global issues from an Asian perspective