How the Global Financial System Works

On an average day in April 2025, about $9.6 trillion of foreign exchange changed hands, according to the Bank for International Settlements (BIS), the Basel-based institution that surveys currency markets every three years. The US dollar was on one side of 89% of those trades. No treaty created that arrangement and no single authority runs it. It is a stack of banks, central banks, messaging networks, and international institutions that mostly cooperate and occasionally fail together. This article walks through each layer and then through the breakdown of 2008.

Key takeaways

• Commercial banks create most money. When a bank makes a loan, it creates a matching deposit. The Bank of England says the majority of money in the modern economy is created this way.
• Central banks set the price of credit, not the quantity of money directly. The Federal Reserve's main tool is a target for the federal funds rate, the overnight rate at which banks lend reserves to each other.
• The dollar's role is large but slowly eroding. Its share of allocated central bank reserves fell from about 70% in 2000 to about 57% at the end of 2025, per IMF data.
• SWIFT is a messaging network, not a bank. It carries payment instructions between institutions and does not hold or move funds.
• The 2008 crisis was a leverage and funding crisis. Mortgage losses were the spark; short-term borrowing against opaque assets was the fuel.
• The IMF and World Bank do different jobs. The IMF handles balance-of-payments emergencies; the World Bank Group finances development.

What are the layers of the global financial system?

The easiest way to hold the whole thing in your head is to think of plumbing in a large building. Households and companies are the taps. Commercial banks are the pipes that deliver money to them. Central banks are the pumps and pressure valves. Payment networks are the junction boxes where pipes from different buildings connect, and international institutions are the building inspectors who step in when something leaks. The table below maps each layer to its job.

Layer	Examples	Main job
Commercial banks	JPMorgan Chase, HSBC, Deutsche Bank	Take deposits, make loans, create most money
Central banks	Federal Reserve, European Central Bank, Bank of Japan, People's Bank of China	Set policy rates, supply reserves, act as lender of last resort
Payment and messaging networks	SWIFT, Fedwire, CHIPS, T2, CLS, CIPS	Carry instructions and settle payments
Markets	Foreign exchange, government bonds, derivatives	Price currencies, interest rates, and risk
International institutions	IMF, World Bank Group, BIS	Emergency lending, development finance, central bank coordination
Regulators and standard setters	Basel Committee, national supervisors	Set capital and liquidity rules for banks

No layer works alone. A central bank's rate decision changes what commercial banks charge, which changes what markets price, which changes the flow of money across borders through payment networks. The rest of this article follows that chain from the bottom up.

How do banks create money?

A common story says banks take in deposits and lend them out, acting as a middleman between savers and borrowers. It sounds right and it is mostly wrong. The Bank of England, in its 2014 Quarterly Bulletin article on money creation, states that the majority of money in the modern economy is created by commercial banks making loans, and that lenders do not simply pass along the funds that savers have deposited.

Here is the mechanism with round numbers. You take out a $200,000 mortgage. The bank does not walk to a vault, count out $200,000 of other customers' savings, and hand it over. It adds a $200,000 loan to the asset side of its balance sheet and, at the same moment, credits $200,000 to your deposit account on the liability side. New money now exists that did not exist a minute earlier. When you pay the seller, that deposit moves to the seller's bank, and the money stays in the system until the loan is repaid, at which point it disappears.

Banks create money by lending, and the money disappears when the loan is repaid. The size of the whole system is limited by the price of credit and by regulation, not by a fixed pool of savings.

If that is true, what stops a bank from lending without limit? Three things do.

• Profitability. Each loan must earn more than the bank pays for funding. Central bank interest rates set the baseline for that cost, which is why the Bank of England says total money ultimately depends on central bank policy.
• Capital rules. Regulators require banks to hold equity (money from shareholders that can absorb losses) against their assets. A bank with thin capital cannot safely expand its loan book.
• Liquidity needs. When you spend your new deposit, it usually leaves the bank for another bank. The lender must be able to settle that transfer with reserves (balances at the central bank) or by borrowing them.

Why can a healthy bank still fail in a day?

A bank's assets, such as mortgages and business loans, are long-term and hard to sell quickly. Its liabilities, such as checking accounts, can be withdrawn on demand. That mismatch is the entire business model, and it is also a standing vulnerability. If enough depositors decide at once that their money is at risk, the bank cannot sell its loans fast enough to pay them, even if the loans are sound. The fear becomes self-fulfilling.

Three tools exist to manage this. Deposit insurance removes the reason to run: in the United States, deposits are automatically insured up to at least $250,000 at each FDIC-insured bank, according to the FDIC. Central banks can lend to solvent banks against collateral, which is the lender-of-last-resort function. And regulators supervise liquidity so that banks hold enough easily sold assets to survive a bad month.

A useful analogy is a theater with one exit. It works perfectly when people leave one at a time. A shout of "fire" does not change the building, but it changes how everyone behaves. Deposit insurance is a credible announcement that there is no fire.

What do central banks actually do?

A central bank is a bank for banks. Commercial banks keep reserve accounts there, and those reserves are how banks settle payments with each other. Central banks also set the interest rate that anchors all other rates and stand ready to lend when private lenders will not. For a deeper tour of how they steer the economy, see how central banks work and how central banks control the money supply.

The Federal Reserve is the best-known example. Its guidance says the Federal Reserve Act directs it to promote "maximum employment, stable prices, and moderate long-term interest rates," and the Federal Open Market Committee (FOMC) treats 2% inflation, measured by the personal consumption expenditures price index, as the level most consistent with that mandate. Its primary tool is a target for the federal funds rate, "the interest rate that banks pay to borrow reserve balances overnight." The Fed nudges that rate by changing the interest it pays on bank reserves, and the change ripples outward into mortgage rates, corporate borrowing costs, asset prices, and exchange rates. The mechanics of that ripple are covered in why interest rates affect everything.

What is quantitative easing, and how big did it get?

When the policy rate hits roughly zero, a central bank cannot cut further. In 2008 the Fed turned to two other tools. One was forward guidance, signaling how long rates would stay low. The other was large-scale asset purchases, popularly called quantitative easing (QE): buying Treasury and mortgage-related securities to push down longer-term interest rates. According to the Fed, it bought roughly $3.7 trillion of longer-term Treasury and agency securities between 2008 and 2014. The first large program began in November 2008.

The Fed's balance sheet is the scoreboard. Federal Reserve data via the St. Louis Fed's FRED database show total assets of about $905 billion on September 3, 2008, a peak of about $8.97 trillion on April 13, 2022, and roughly $6.76 trillion on October 14, 2026. The Fed began gradually reducing its securities holdings in October 2017, a process often called quantitative tightening, and the fall from the 2022 peak reflects the same tool in use again.

QE is frequently described as "printing money and giving it to banks." That is a simplification. The Fed pays for the bonds by creating reserves, which only banks can hold, so the first-round effect is on bank balance sheets and on the prices of the assets it buys. Whether this lifts lending, inflation, or mainly asset prices is still debated among economists.

Which other central banks matter most?

The Federal Reserve was created by the Federal Reserve Act of 1913. The Bank of England dates to 1694, which makes it one of the oldest central banks still operating. The European Central Bank, founded in 1998, sets monetary policy for the euro area, with national central banks such as the Bundesbank carrying out its decisions. The Bank of Japan and the People's Bank of China run the monetary policy of two of the world's largest economies. One institution sits above them all in a different sense: the BIS, founded in 1930 and owned by 63 central banks that together account for about 95% of world GDP. It describes its role as acting as "a bank for central banks," and it hosts the Basel Committee on Banking Supervision.

Why does the US dollar dominate?

The dollar's role has three layers: it is the currency traded most, the currency held most in reserve, and the currency in which much of the world invoices and borrows. Each layer rests on history.

How did the dollar become the anchor?

In July 1944, delegates from 44 nations met at the Mount Washington Hotel in Bretton Woods, New Hampshire, to design the postwar monetary order, according to the Federal Reserve History project. Currencies were pegged to the dollar, "fixed but adjustable (within a 1 percent band)," and the dollar itself was fixed to gold at $35 an ounce. By the 1960s the United States did not hold enough gold to cover the dollars abroad at that price. On August 15, 1971, President Richard Nixon ended the dollar's convertibility to gold, and by March 1973 major currencies were floating, per the US State Department's Office of the Historian.

The formal link broke, but the dollar stayed on top. Economists point to network effects (the currency everyone uses is the one everyone wants), the depth of US Treasury markets, the habit of pricing oil and other commodities in dollars, and the credibility of US legal institutions. A rough analogy is the English language in aviation: no law requires it, but once every pilot and tower uses it, switching is costly for anyone who goes alone.

How large is the dollar's share today?

The numbers differ by measure, and mixing them is a common source of confusion.

Measure	Dollar figure	Source and date
Share of foreign exchange trades with the dollar on one side	89%	BIS Triennial Survey, April 2025
Share of allocated global reserves	69.74% (2000) to 56.77% (2025)	IMF COFER, as tabulated on Wikipedia, January 2026
Euro share of FX trades	28.9%	BIS Triennial Survey, April 2025
Yen share of FX trades	16.8%	BIS Triennial Survey, April 2025

A technical note on the BIS figures: every currency trade has two sides, so the shares add to 200%, not 100%. A trade of dollars for euros counts once toward the dollar and once toward the euro. That is why 89% for the dollar does not mean the dollar is in 89% of the total value in a way that leaves only 11% for everything else.

The reserve share tells a different story. The IMF's COFER database (Currency Composition of Official Foreign Exchange Reserves) shows the dollar's share of allocated reserves sliding from just under 70% in 2000 to about 57% at the end of 2025, while the euro held about 20%. That is a long, slow decline rather than a collapse, and the main beneficiaries were a spread of smaller currencies rather than any single rival. For a country-by-country view, see the ranking of countries with the most foreign exchange reserves and the related list of countries with the largest gold reserves.

What is the "exorbitant privilege"?

The phrase was coined in the 1960s by Valéry Giscard d'Estaing, then France's finance minister and later its president, to describe an asymmetry: because the world needs dollars for trade and reserves, the United States can borrow from abroad at lower cost than it otherwise could. Economist Barry Eichengreen used the term as the title of his 2011 book on the dollar. The benefit is real but comes with costs, including a dollar that can stay strong when US exporters would prefer it weaker, and exposure to global demand for safe assets. How that borrowing accumulates is explored in countries with the highest national debt and in the Related Reading list below.

Can a currency be used as a weapon?

Yes, and that is the main reason other governments want alternatives. Almost all large international banks need access to dollar clearing, so a decision in Washington to cut a bank off from dollar payments can isolate it from much of global trade. Sanctions on Iran, North Korea, and Russia have relied on this reach. China has responded by building the Cross-Border Interbank Payment System (CIPS), a renminbi payment network. One compilation of its membership lists more than 1,400 participating institutions across over 100 countries and regions, still far smaller than SWIFT's footprint.

Building a rival currency is harder than building a rival pipe. Reserve currencies need deep, open, legally predictable bond markets that foreign governments trust to let them in and out freely. Capital controls and political risk make that a high bar, which is why the dollar's slow decline in reserves has not translated into one obvious successor. Gradual diversification across the euro, yen, pound, and smaller currencies looks more likely than a sudden handover.

How does money move between banks and across borders?

People often picture international payments as a single message that sends money from one country to another. In practice it is a relay.

What is SWIFT, and what is it not?

SWIFT, the Society for Worldwide Interbank Financial Telecommunication, was founded in 1973 in Brussels. It is a cooperative under Belgian law owned by its member banks and based in La Hulpe, near Brussels. By 2015 it linked more than 11,000 financial institutions in over 200 countries and territories, carrying an average of more than 32 million messages a day, up from 2.4 million a day in 1995. The key fact is what it does not do: SWIFT carries payment instructions between institutions and does not hold funds, manage accounts for third parties, or perform clearing or settlement.

Think of SWIFT as the postal system for banks and the actual transfer of value as the bank vaults on each end. A SWIFT message says "debit my account with you and credit this account at that bank." The value moves because the banks have accounts with each other or with a central bank.

How does a cross-border payment actually settle?

Suppose a company in Germany pays a supplier in Vietnam. Neither company's bank may have an account with the other's. The payment often passes through one or more correspondent banks, institutions that hold accounts for other banks, with each hop debiting and crediting those accounts and sending its own message. Every hop adds a fee, a delay, and a compliance check, which is a large part of why cross-border payments are slower and costlier than domestic ones. Remittance flows, where migrants send money home in small amounts, feel that cost most, as the ranking of countries that send the most remittances illustrates.

Domestic settlement happens in "real-time gross settlement" systems run by central banks. In the euro area that system is T2, which replaced TARGET2 in March 2023 and, according to the ECB, processes euro payments with a combined value roughly equal to the euro area's annual GDP every eight days. The United States has Fedwire and the private CHIPS network, and each major currency has its own equivalent.

What is settlement risk in currency trading?

Currency trades involve two payments in two countries, often in different time zones. If one side pays and the other defaults before paying, the first party loses the full principal, not just a price difference. Continuous Linked Settlement (CLS), established in 2002, addresses this by settling both legs at once, a method called payment versus payment. CLS says it settles in 18 of the most actively traded currencies and settles more than $8.0 trillion on average every day. Without such a system, a growing trade volume would multiply the number of places a failure could start.

Who gets cut off from the network?

Because SWIFT is a Belgian cooperative subject to European law, it can be directed to disconnect institutions under sanctions. In March 2012 it disconnected Iranian banks that the EU had identified as breaching sanctions, and most Iranian banks reconnected in February 2016. In 2022, the EU, UK, Canada, and United States agreed to remove several Russian banks from SWIFT's messaging system after the invasion of Ukraine. The effect of an exclusion is real but partial. Banks can use other messaging channels, telephone, or intermediaries, but each workaround adds cost and friction. The fact that governments use the system as an instrument of policy is exactly the incentive that pushes others to build alternatives.

What went wrong in 2008?

The financial crisis of 2007 to 2009 is the clearest demonstration of how the layers above can fail together. Mortgage losses were not large enough, by themselves, to destroy the system. What turned them into a global crisis was how the risk was packaged, financed, and spread.

How did a mortgage problem become a global crisis?

Start with the raw material. Before the subprime expansion, US homeownership fluctuated around 65%, according to the Federal Reserve History project. Lending standards loosened, and some loans were made to borrowers who could not repay them unless house prices kept rising. Lenders could sell these loans immediately to investment banks, which bundled them into mortgage-backed securities (MBS). Because the originator no longer held the loan, the incentive to check whether it would be repaid weakened.

Banks then sliced those securities into tranches, layers with different priority for repayment. The senior layers were rated AAA on the assumption that house prices would not fall everywhere at once. The AAA label let pension funds, insurers, and banks around the world buy them. Think of a sausage factory in which no one examines the meat: each step only checks the casing handed to it by the previous step.

The final ingredient was leverage, borrowing to buy assets. When a firm funds a big position with short-term loans that must be renewed every few days, small losses can force it to sell, and sales push prices down further. That loop is explained in margin trading and leverage, and the speed of the freeze connects to why liquidity matters in markets.

What happened, step by step?

The table uses dates from the St. Louis Fed's FRASER financial crisis timeline unless noted.

Date	Event
April 2007	New Century Financial, a leading subprime lender, files for bankruptcy (Federal Reserve History)
June 7, 2007	Bear Stearns suspends redemptions from one of its mortgage-focused hedge funds
July 31, 2007	Bear Stearns liquidates two hedge funds that invested in mortgage-backed securities
March 14, 2008	The Fed approves financing for JPMorgan Chase's acquisition of Bear Stearns
September 7, 2008	Fannie Mae and Freddie Mac are placed in government conservatorship
September 15, 2008	Lehman Brothers files for Chapter 11 bankruptcy protection
September 16, 2008	The Fed authorizes up to $85 billion in lending to AIG; the Reserve Primary Fund's net asset value falls below $1
October 3, 2008	Congress passes the Emergency Economic Stabilization Act, creating the $700 billion TARP

The Lehman filing mattered less for its size than for what it showed. Creditors learned that a major institution could be allowed to fail, and money market funds, which many companies treat as a cash equivalent, suffered when the Reserve Primary Fund "broke the buck" a day later. Lenders stopped trusting each other, and short-term funding markets that had looked reliable seized up.

How big was the response and the damage?

The Fed cut its target rate from 4.5% at the end of 2007 to 2% in early September 2008, and then to a range of zero to 0.25% by the end of 2008. It gained authority to pay interest on bank reserves in October 2008 and began large-scale asset purchases the next month. The recession lasted 18 months, from December 2007 to June 2009 according to the National Bureau of Economic Research dating cited by the Fed. Unemployment more than doubled from under 5% to 10%, and output fell 4.3% from peak to trough, the deepest postwar decline up to that point.

TARP's final accounting is less dramatic than the $700 billion headline. The Treasury reports that about $443.5 billion was disbursed, that the government collected about $443.1 billion including proceeds from AIG shares, and that the lifetime cost was approximately $31.1 billion, most of it for efforts to help homeowners avoid foreclosure. All programs had closed as of September 30, 2023. The headline number measured the authority to act; the cost measured what the rescue ultimately lost.

What changed afterward?

The Basel Committee published its first Basel III standards in December 2010. The package raised the quality and quantity of bank capital, added a Liquidity Coverage Ratio (finalized in January 2013) so banks hold enough easily sold assets to survive a 30-day stress, and added a Net Stable Funding Ratio (October 2014) to limit reliance on short-term funding. The post-crisis reforms were completed in December 2017. National regulators added stress tests, in which supervisors check whether large banks would survive a hypothetical severe recession.

Reform lowers the odds of a repeat in the same form. It does not prevent a different one. Financial history suggests that stress appears where regulation is thin and the rewards for taking risk are high, which is a theme the guide to what causes recessions also covers.

What do the IMF, World Bank, and BIS do?

The two institutions created at Bretton Woods in July 1944 often get confused. The IMF formally came into existence in December 1945 when its first 29 member countries signed its Articles of Agreement, per the Federal Reserve History project. The World Bank Group grew from the same conference.

Institution	Core job	Typical customer	Typical product
International Monetary Fund (IMF)	Support stability of the international monetary system	Country facing a balance-of-payments crisis	Loans with policy conditions
World Bank Group (IBRD, IDA, IFC, MIGA, ICSID)	Reduce poverty and finance development	Developing-country governments and private firms	Long-term loans, grants, guarantees, advice
Bank for International Settlements (BIS)	Cooperation among central banks	Central banks	Research, statistics, hosting the Basel Committee

The IMF acts like an emergency room for national finances. A country that cannot pay for imports or service foreign debt can borrow, usually in exchange for commitments on budgets and reforms. Critics argue those conditions can deepen recessions and hit the poor hardest; defenders argue lending without conditions would not restore creditworthiness. Both views have evidence behind them, which is why the debate is not settled. Some Fund decisions, such as changes in voting shares, require an 85% supermajority, and the United States holds about 16.5% of the votes, enough to block them alone.

The World Bank states its mission as creating "a world free of poverty on a livable planet" and says it works in 130 countries. Its institutions have different tasks: the International Bank for Reconstruction and Development lends to middle-income governments, the International Development Association serves the poorest countries, and the International Finance Corporation invests in private firms. Interest rates, risk premiums, and debt service all depend on how investors price bonds, a topic covered in understanding bonds and fixed income.

How does a crisis in one country spread to others?

Contagion travels through four main channels.

1. Trade. A recession in one economy lowers its imports, which are another economy's exports.
2. Finance. Investors who lose money in one market sell assets in others to meet margin calls or reduce risk, which pushes prices down everywhere.
3. Currency effects. A stronger dollar raises the cost of repaying dollar-denominated debt for borrowers outside the United States, which tightens conditions in emerging markets.
4. Confidence. When investors reassess how risky "safe" assets are, they pull money out of all risky ones at once.

The 2008 crisis used every channel. It began in the US mortgage market and reached Europe through bank balance sheets that held American securities, then reached emerging markets through trade and funding. Inflation adds another transmission route, because rate increases designed to cool prices in rich countries change borrowing costs worldwide, as described in how inflation works.

What do people commonly get wrong?

"SWIFT moves money." It does not. It carries messages, as covered above.

"Banks lend out your deposits." A loan creates a deposit rather than reallocating one, as the Bank of England explains. The constraint on lending is profitability, capital, and liquidity, not a stockpile of other people's savings.

"The Fed prints money and hands it to the government." The Fed's asset purchases create reserves for banks and are conducted in markets, not by handing cash to the Treasury. As the St. Louis Fed has put it in its crisis explainer, "the Fed doesn't spend government money."

"The dollar is about to be replaced." Reserve shares have declined gradually for 25 years, but trading, invoicing, and debt markets remain heavily dollar-based. A slow shift to a more multipolar system is more consistent with the data than a sudden replacement.

"Cryptocurrency has displaced banks." Bitcoin and similar assets offer payment rails outside the banking system, but volatility, transaction costs, and limited acceptance have kept them a small part of everyday commerce. Their mechanics are covered in what Bitcoin is and how it works and how blockchains work. Central bank digital currencies are a separate approach that governments are studying and, in some cases, piloting.

Frequently asked questions

Q: Who controls the global financial system? A: No one actor does. Rules come from the Basel Committee, national regulators, SWIFT's governance, and IMF conditions, while market prices come from millions of participants. The United States has the largest single influence through the dollar, the Federal Reserve, and its IMF voting power, but the European Central Bank, the Bank of Japan, and the People's Bank of China all matter.

Q: What happens when a country defaults on its debt? A: It depends on who holds the debt and in which currency. Typically the government negotiates with creditors to extend maturities, cut interest, or reduce principal, often with IMF involvement. The usual consequences are lost market access, a weaker currency, and an economic contraction.

Q: What is a currency crisis? A: It is a sharp fall in a currency's value when investors lose confidence in a country's ability to repay foreign debt or defend its exchange rate. Examples economists often cite include the 1997 Asian financial crisis, Russia in 1998, Argentina in 2001, and Turkey in 2018. The causes of exchange-rate moves in general are covered in why currency exchange rates change.

Q: Why does the dollar's share differ between trading and reserves? A: The two measure different things. The BIS figure counts how often the dollar appears in currency trades, which reflects its role as a bridge between other currencies, while the IMF figure measures what central banks choose to hold. A bridge currency can stay dominant in trading even as reserve managers diversify.

Q: Could 2008 happen again? A: A crisis of the same form is less likely because banks hold more capital and liquidity under Basel III and face stress tests. Risk can still build in less regulated corners of finance, and no set of rules removes the tension between financial innovation and hidden fragility.

Q: Is my bank deposit safe? A: Deposit insurance protects balances up to a limit, which the FDIC states is at least $250,000 at each insured US bank. This article is educational and not personal financial advice. Rules and limits vary by country and account type, so check with your own bank or regulator.

The takeaway

The global financial system is less a machine than an agreement. Banks create money because regulators and depositors trust that the money will be accepted. Central banks set the price of credit because markets believe the rate will hold. The dollar anchors trade because switching costs are high, and SWIFT works because every bank is already connected to it. When trust is intact, the layers hum along invisibly. When trust breaks, as it did at Lehman in September 2008, the same interconnections that made the system efficient make the failure spread. Reading the headlines on rates, sanctions, or reserves becomes easier once you can place each story on the map above and ask which layer is under strain.

Related Reading

• How Does the US National Debt Work — and Should We Be Worried?
• What Is the Stock Market — and How Does It Actually Work?
• How Demographics Will Reshape the Global Economy: The Population Time Bomb
• How Climate Change Works: The Science Explained
• How the Human Brain Works

Sources

• BIS, "Global FX trading hits $9.6 trillion per day in April 2025" (Triennial Survey press release)
• BIS, Basel III framework and About the BIS
• Bank of England, "Money creation in the modern economy" (Quarterly Bulletin 2014 Q1)
• Federal Reserve, "Monetary Policy: What Are Its Goals? How Does It Work?"
• Federal Reserve History, "The Great Recession and Its Aftermath" and "Creation of the Bretton Woods System" and "The Subprime Mortgage Crisis"
• St. Louis Fed FRASER, Financial Crisis Interactive Timeline
• St. Louis Fed FRED, Federal Reserve total assets (WALCL)
• US Treasury, Troubled Asset Relief Program
• US Office of the Historian, "Nixon and the End of the Bretton Woods System"
• ECB, T2 (replaced TARGET2 in March 2023) and CLS Group
• FDIC, Deposit insurance and World Bank, Who we are
• SWIFT overview, Reserve currency (IMF COFER data), and Exorbitant privilege

Figures are as of the dates stated; foreign exchange, reserve, and balance-sheet numbers change over time.