BIS Warns Global Finance Splitting into Blocs- Central Bank Trust a Key Factor!

The 2024-25 BIS Annual Report highlights how rising geopolitical tensions and trade realignments are reshaping global capital flows, reinforcing the US dollar’s central role while accelerating financial contagion risks. Central banks must safeguard trust and stability in an increasingly fragmented and digitalized financial landscape.

• Geopolitical tensions are driving a reconfiguration of trade and capital flows into regional blocs, lengthening supply chains and increasing vulnerability to shocks, especially through weaker links in extended networks, challenging traditional global economic structures and heightens financial risks.

• The US dollar remains the dominant currency in international finance, strongly influencing global risk appetite and investment flows, particularly impacting emerging markets where a strong dollar can constrain market liquidity and dealer capacity.

• Central banks must act as “Guardians of Trust” amidst rapid digital innovation and AI adoption, ensuring that digital money remains anchored in central bank reserves to maintain stability, elasticity, and integrity of the financial system. The future financial ecosystem will rely on programmable tokens built on trusted central bank money, requiring cooperation and robust governance

“Reconfiguration” of trade and capital flows amidst rising geopolitical risk; trade value contractions between geopolitically distant countries; coupled with the enduring centrality of the US dollar, suggest a financial world reorganizing into blocs, per the 2024-25 annual report of the Bank of International Settlements (BIS). This raises the stakes for cross-border investment strategies and calls for sophisticated geopolitical risk modelling. Financial conditions are now transmitting more swiftly across economies due to structural shifts in the global economic system.

Geopolitical tensions, warns the BIS annual report, can lead to a reallocation or diversion of trade flows, which brings its own financial implications. This can lead to a lengthening of global supply chains, as direct links between geopolitically distant countries get rerouted through other countries to create indirect links between them.

While interfirm financial links can be stabilizing, weak firms may transmit shocks to their trading partners, and longer chains are more vulnerable to weak links.

In spite of geopolitical tensions, research explored how the role of the dollar in

international finance continues to be central. The dollar is linked to the risk appetite of international investors and drives flows to local currency bonds and equities in both advanced and emerging market economies. More broadly, research examined how exchange rates affect the asset allocation of global bond portfolio investors. The strength of the dollar – and the financial channel of exchange rates generally – is particularly relevant for emerging markets. For instance, a strong dollar can affect Treasury market liquidity by limiting the market intermediation capacity of emerging market dealers.

Despite these tensions, research shows that the US dollar remains a crucial player in international finance. The value of the dollar affects how willing investors are to take risks, which in turn influences where they put their money, such as in local currency bonds and stocks in different countries. Exchange rates also play a role in how investors decide where to invest their money.

Emerging markets, in particular, are affected by the strength of the dollar. A strong dollar can limit the ability of emerging market dealers to trade in US Treasury bonds, which can impact market liquidity. The global tightening of monetary policy and the rise in the dollar’s value were expected to cause problems for emerging markets, but careful decision-making by policymakers and strong financial systems in these markets helped to mitigate these issues.

The BIS expresses some truly significant observations about the role of central banks in the context of the rise of digital currency. The core message is that money is becoming like digital Lego blocks. Central banks make sure these blocks don’t crumble.The future financial system will resemble a “digital playground” built on trusted central bank money and programmable tokens. This ensures money remains safe, elastic, and universally accepted—while enabling faster, cheaper, and smarter transactions. Central banks are the architects; tokenization is the tool.

Central Banks, according to BIS should remain the Guardians of Trust. All digital innovation must be anchored in central bank money (like reserves) to ensure stability. Private alternatives, the BIS argues, fail three key tests – (a) Singleness: Money must be universally accepted at face value; (b) Elasticity: The system must flexibly supply money to avoid gridlock (e.g., during crises), and (c) Integrity: Money must be resistant to illicit activities (e.g., fraud, money laundering). It is the duty of central banks to provide this trust that private digital currencies do not.

BIS underscores the influence that technology was having over the banking system around the world especially the use of artificial intelligence (AI) and machine learning – in particular large language models (LLMs), generative AI (gen AI) and AI agents. Central banks, it observes, were directly affected by AI, both in their role as stewards of monetary and financial stability and as users of AI tools. To address emerging challenges, central banks need to anticipate AI’s effects and harness AI in their own operations. Data availability and data governance are key enabling factors for central banks’ use of AI, and both rely on cooperation. Central banks need to foster a “community of practice” to share knowledge, data, best practices and AI tools.

Looking at the future, the BIS warns that long-standing economic relationships that have sustained global prosperity for decades were now under strain.  The global economy was already wrestling with structurally low productivity growth, persistently weak fiscal positions and the build-up of large and often opaque non-bank financial positions. Rapid and disruptive technological changes pose significant challenges of their own. The trust factor of Central banks, have never been so critical according to the BIS. Central banks need to deal with the immediate fallout while keeping top of mind the deeper, structural weaknesses that threaten the resilience of the global economy. Success will depend on maintaining public trust – trust in central banks’ capacity to act and do so in the public interest. Trust in their commitment to low inflation was decisive in quelling pandemic-era inflation. Now, trust in public institutions – including the trust in money – needs to serve as a fixed point for others to rally around.