Title of essay:

The Dynamic Landscape of Global Finance: Assessing the Impact of Shadow Banking,
Crypto-currencies, and the Rise of BRICS on the International Financial System

The Module Name:

Evaluating the Global Context

The Module Code: (UMSDPM-15-M)

Word Count: 2200 words

Student Number:

Introduction

The international financial system a complex web of institutions, regulations, and transactions, is
undergoing significant transformations driven by various phenomena, including the rise of
shadow banking, the advent of crypto currencies, and the emergence of the BRICS nations as
transformative force (Brazil, Russia, India, China, and South Africa and 6 more countries will be
effective on 1st January 2024). These developments present a complex interplay of challenges
and opportunities, raising questions about their potential impact on the stability and structure of
the global financial landscape. While each phenomenon carries its own set of opportunities,
they also pose significant threats to the stability and traditional structures of the international
financial system.

I. Shadow Banking: Risks and Opportunities

Shadow banking, a term encompassing a wide array of financial activities conducted outside the
conventional banking sector, has gained prominence in the global financial landscape. While
shadow banking offers alternative sources of funding and financial innovation, its unregulated
nature also raises concerns about lack of transparency, systemic risks and financial stability.

Threats to the International Financial System

One of the primary concerns associated with shadow banking is the heightened systemic risk it
introduces. The lack of regulatory oversight and transparency may lead to the buildup of
financial vulnerabilities, potentially triggering a chain reaction that could threaten the stability of
the broader financial system. Moreover, the complexity of some shadow banking activities
makes it challenging for regulators to assess and mitigate risks effectively. This opacity
increases the difficulty of identifying potential sources of instability, raising alarms about the
resilience of the international financial system in the face of unforeseen challenges.

Opportunities and Innovation

Conversely, proponents argue that certain aspects of shadow banking contribute to financial
innovation and can serve as alternative sources of funding. Non-traditional lending channels
and financial products can enhance market efficiency and provide businesses with access to
diverse funding options. However, realizing these opportunities requires a delicate balance,
necessitating effective regulation to prevent excessive risk-taking and ensure financial stability.
(Errico, Loukoianova 2014)

II. Cryptocurrencies: Balancing Disruption and Integration

A crypto currency is a digital or virtual currency that uses cryptography for security and is
generally based on block chain technology, a distributed ledger enforced by a disparate network
of computers. Crypto currencies, epitomized by Bitcoin and Ethereum, represent a
decentralized form of digital or virtual currency. They operate on block chain technology,
offering secure and transparent transactions without the need for traditional intermediaries.
Challenges to the International Financial System

Cryptocurrencies have emerged as a disruptive force in the international financial system,

challenging traditional norms and reshaping the dynamics of global finance. As this digital
revolution gains momentum, it prompts a critical examination of the balance needed between
embracing disruption and integrating cryptocurrencies into the established financial framework.

Critics often highlight several challenges associated with cryptocurrencies. One major concern
is their potential use in illicit activities, facilitated by a relative degree of anonymity. Regulatory
uncertainties surrounding crypto currencies also pose challenges for traditional financial
frameworks, as authorities grapple with how to integrate these digital assets without
compromising security and stability.

The volatility of crypto currency markets is another area of apprehension, as sharp price
fluctuations can impact investors, financial institutions, and the broader economy. Moreover, the
lack of consumer protection mechanisms raises questions about the resilience of the financial
system in the event of market disruptions or fraud.

Opportunities and Innovation

On the flip side, crypto currency advocates emphasize the potential for financial inclusion and
efficiency gains. Crypto currencies enable faster and cheaper cross-border transactions,
reducing reliance on traditional banking systems. Block chain technology, the underlying
innovation behind crypto currencies, has broader applications, including enhancing
transparency, security, and efficiency in various financial processes (Davis Chu | Victoria
Schumacher, 2022)

Shadow Banking in Crypto currency:

Shadow banking in the cryptocurrency realm arises due to the largely unregulated nature of the
digital asset space, dissuading traditional financial institutions from extending financing against
digital assets.

As a consequence, investors and speculators are turning to shadow banking entities within the
cryptocurrency sector for leverage. Hedge funds, as reported by Business Times, opt to secure
loans to acquire cryptocurrency at the current market price and simultaneously engage in
futures trading to capitalize on basis opportunities, potentially yielding significant profits for both
the borrower and the shadow banking entity under favorable conditions.

Matt Levine, writing for Bloomberg.com, details an alternative manifestation of shadow banking
within the crypto landscape. Celsius, a prominent "Crypto Bank," enticed users by offering
exceptionally high weekly interest payments in exchange for depositing Bitcoin, Ethereum, or
Tether. Celsius then lent out these deposited cryptocurrencies to borrowers at even higher
interest rates.

Despite attracting over $25 billion from retail and institutional investors with deposit rates
reaching up to 18%, Celsius faced a notorious collapse in July 2022. This downfall was
attributed to declining cryptocurrency prices, excessively risky lending practices, and allegations
of fraudulent activities. (Bloomberg, Matt Levine 2022)

China’s case study relating to shadow banking:

China's experience serves as a cautionary tale for those expressing concerns about the risks
associated with unregulated shadow banking. In the aftermath of the global financial crisis, the
Chinese government utilized fiscal stimulus and accessible credit to drive economic growth,
primarily funneled through shadow banks associated with traditional financial institutions. The
non-bank sector's share of the financial industry surged from 8% in 2009 to a third in 2016.

While the Chinese government tacitly supported this trend, the system's increasing leverage led
to a surge in problematic loans, elevating credit risks in financial markets. The stock market
crash in 2015, resulting in major share value losses, prompted authorities to recognize the
threat posed by the growing non-bank sector to financial stability. Subsequent regulatory
reforms curtailed the lending capabilities of shadow banks, primarily by reducing the permissible
interest rates. This move caused China's shadow banking assets to shrink from over 100% of
GDP to around 80%, contracting by RMB11.5 trillion ($1.6 trillion) between 2017 and 2020.

Real estate, a major user of shadow banking channels, faced challenges as property
developers grappled with the deleveraging campaign. This has contributed to a crisis in the
sector, which constitutes up to 30% of China's economy. Property developers are now at risk of
bankruptcy, and the crisis is affecting the financial sector as falling property sales test the
solvency of non-bank institutions. Chinese trusts defaulted on around $9 billion in real estate-
linked financial products in the latter half of 2022.

Looking ahead, there are suggestions for further development of China's bond and stock
markets to address the challenges posed by the shadow banking system. While the West may
not have an exact parallel to China's system, there are valuable lessons emphasizing the
importance of providing finance to SMEs, early regulation, and the need for market-based
solutions. (Katsomitros,2023)

III. The BRICS Phenomenon: Shifting Economic Power and Global Dynamics

Overview of BRICS

Brazil, Russia, India, China and South Africa, originally an informal group named BRICS,the
leading emerging economies of the early 2000s, have since experienced very different growth
paths. The former Goldman Sachs economist (and now crossbench peer) Jim O’Neill coined the
term BRIC in the early 2000s to describe the four fast-growing countries that, at the turn of the
millennium, seemed most likely to begin catching up with the West (O’Neill, 2001). The rise of
the BRICS nations marks a significant shift in the global economic landscape. These countries,
with diverse economies and substantial populations, have gained prominence in international
affairs, challenging the traditional dominance of Western economies.

In fact, the story of the BRICS is largely about China’s staggering rise. Its development has
been so sustained over such a long period of time that it has genuinely reshaped the distribution
of global economic power (Bishop, 2016).

Challenges to the International Financial Order

The growing influence of BRICS poses challenges to existing international financial institutions
and governance structures. As these nations assert themselves economically, questions arise
about the representation and decision-making processes within institutions like the International
Monetary Fund (IMF) and the World Bank. Reforms to these institutions are necessary to reflect
the evolving balance of economic power on the global stage.

Moreover, the increased economic interconnectedness with BRICS nations means that
economic fluctuations in these countries can have ripple effects across the globe. The potential
for trade imbalances, currency volatility, and geopolitical tensions requires careful consideration
to ensure a stable international financial environment.

Opportunities for Collaboration and Diversification

Despite the challenges, the emergence of the BRICS bloc also presents opportunities for
collaboration and diversification. A more inclusive global economic order that incorporates the
perspectives and contributions of these nations can foster a more resilient and adaptable
international financial system.

BRICS countries are establishing their own institutions, such as the New Development Bank,
providing an alternative to traditional lending institutions. This diversification of financial
channels can contribute to a more robust and flexible global financial architecture. (Oxford
University Press, 2021)

Economic Influence and Institutional Challenges

The rise of the BRICS nations—Brazil, Russia, India, China, and South Africa—signals a shift in
global economic power dynamics. These nations, collectively representing a substantial share
of the world's population and economic output, challenge the dominance of traditional Western
powers. This shift brings about challenges to existing international financial institutions, where
representation and decision-making structures may not adequately reflect the evolving
economic landscape.

Geopolitical and Systemic Implications

The geopolitical implications of the BRICS phenomenon extend beyond economics. Increased
economic interdependence and geopolitical tensions may create systemic risks for the
international financial system. Trade imbalances, currency fluctuations, and potential conflicts of
interest introduce uncertainties that necessitate careful consideration and proactive measures
from global financial stakeholders. (Acharya, 2018)

BRICS de-dollarize the global financial system:

The 15th BRICS summit marked a significant development with the inclusion of six new member
countries – Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the UAE – set to join the group
on January 1, 2024. A notable outcome of the summit was the collective commitment to explore
an alternative multilateral currency to replace the US dollar. This move is aimed at providing
additional payment options for emerging markets and developing economies (EMDE), reducing
their susceptibility to fluctuations in the dollar exchange rate. The initiative, however, faces
competition from existing alternatives such as special drawing rights (SDRs) and the euro.
The call for de-dollarization is not a recent phenomenon, as global leaders and economists have
voiced concerns about the destabilizing impact of the dollar's dominance on the international
monetary and financial system since the 1960s. The geopolitical context, especially with
Russia's invasion of Ukraine, has further spurred countries, including US allies like India, to
explore non-dollar trading mechanisms with Russia. Notably, the Chinese yuan has gained
prominence as the most traded currency in Russia.
UN Secretary-General Antonio Guterres, a participant in the BRICS expansion announcement,
has long advocated for reforms in the international financial system. The dominance of the
dollar raises concerns about the undue influence of US monetary policy and political decisions
on smaller economies and competitors. China, as the world's second-largest economy, faces
vulnerability to "dollar shocks," particularly amid challenges in its real estate market. The
People's Bank of China has adjusted its rates in contrast to the US Federal Reserve's efforts,
leading to a decline in the yuan's value against the dollar.
According to a Brookings Institution research paper entitled, "US interest rate increases and
crisis probabilities in developing economies," shocks that have driven US interest rates upward
during 2022 are especially likely to trigger financial crises in the developing world. "Further
increases in US interest rates can result in more widespread currency distress, given the
increase in EMDE debt and the depletion of foreign currency reserves that has taken place of
late," it concludes.

Despite the challenges, de-dollarization is gaining traction. In 2023, BRICS surpassed the global
GDP contribution of the G7 countries, accounting for nearly one-third of the world's economic
activity. The share of the US dollar in official foreign exchange reserves reached a 20-year low
in the final quarter of 2022, adjusted to 47 percent when accounting for exchange rate changes.
Although the dollar still dominates global trade, BRICS has made significant strides in financial
cooperation. The establishment of institutions such as the New Development Bank and the
Contingent Reserve Arrangement reflects the bloc's commitment to creating a global financial
system less dependent on the US dollar. (Li, Yuefen, 2023)

Conclusion: Navigating the Future of International Finance

In conclusion, the phenomena of shadow banking, crypto currencies, and the rise of the BRICS
nations are reshaping the international financial system in profound ways. While these
developments introduce risks and uncertainties, they also present opportunities for innovation,
inclusion, and collaboration. Addressing the potential threats involves a delicate balance
between regulatory oversight and fostering an environment conducive to financial creativity.
Striking the right balance requires international cooperation and a willingness to adapt
regulatory frameworks to accommodate the evolving nature of finance. The interconnectedness
of these phenomena amplifies the difficulties, requiring a comprehensive and collaborative
approach from regulators, policymakers, and market participants (Smith, 2020).

As the global financial landscape navigates these crossroads, stakeholders must work
collaboratively to design and implement robust regulatory frameworks that address the unique
challenges posed by shadow banking, cryptocurrencies, and the emergence of the BRICS
nations. The path forward requires foresight, international cooperation, and a commitment to
building a resilient financial system capable of withstanding the transformative forces reshaping
the world of finance.
Reference:

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G., AbuShanab, H., Shin, H. S. (2014). Mapping the Shadow Banking System
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 Handbook of BRICS and Emerging Economies edited by PB Anand, Shailaja

Fennell and Flavio Comim (Oxford University Press, 2021).
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 Clash of Powers: US-China Rivalry in Global Trade Governance by Kristen
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 https://www.businesstimes.com.sg/companies-markets/banking-finance/crypto-
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 https://www.worldfinance.com/special-reports/the-dangerous-spread-of-shadow-
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