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Global Finance’s Supply-Chain Revolution

HONG KONG – In March 2011, the catastrophic earthquake, tsunami, and nuclear disaster that hit Japan halted production of key components on which many global supply chains depend. The sudden disruption of these essential materials from the production process forced a reassessment of how these supply chains function. But such vulnerabilities are not confined to the manufacturing sector. The finance industry, too, has suffered its own near “supply chain” meltdown in recent times.

The failure of Lehman Brothers in 2008 not only roiled global financial markets, but also brought global trade practically to a standstill as wholesale banks refused to fund each other for fear of counterparty failure. The simple banking system of the past, one based on retail savings being concentrated in order to fund the credit needs of borrowers, had evolved into a highly complex – and global – supply chain with knock-on risks of disruption comparable to those seen in Japan last spring.

Financial supply chains and those in the manufacturing sector share three key features – architecture, feedback mechanisms, and processes – and their robustness and efficiency depend upon how these components interact.

In today’s financial architecture, as with other supply chains, interdependent networks tend to concentrate in powerful hubs. For example, just two financial centers, London and New York, dominate international finance, and only 22 players conduct 90% of all global foreign-exchange trading. Such concentration is very efficient, but it also contributes to greater systemic risks, because, if the leading hubs fail, the whole system can collapse.