We cannot ignore the conflict between Russia and Ukraine. Its repercussions are being felt in all areas, not least by the financial sector.
The international community has responded to the invasion by disconnecting Russia from SWIFT, largely considered to be the cornerstone of the global financial system.
What reaction could this bring?
Why is SWIFT so important for the financial world?
Often described as the financial WhatsApp, SWIFT (Society for Worldwide Interbank Financial Telecommunication) is the go-to worldwide messaging system used by the international finance sector to communicate.
It’s currently estimated that SWIFT is used by around 11,000 financial institutions and businesses in over 200 countries.
Last year, the system facilitated over 42 million messages per day, including orders, payment confirmations, and currency exchanges.
A SWIFT message contains, for example, information on the identity of the person making a payment, details about the beneficiary, and the corresponding account numbers.
Once the message is received, the banks settle the transfer independently of SWIFT.
SWIFT plays a vital role in vetting cross-border payments. Banks also use it to inform each other of instructed transfers. You could say SWIFT forms the foundation of the global financial system.
Currently, SWIFT is not regulated like a bank. Instead, it operates as an independent organisation that is cooperatively owned and overseen by several major central banks, including the US Federal Reserve, the Bank of England, the European Central Bank (ECB), and governed by European Union (EU) law.
As economic sanctions against Russia’s invasion of Ukraine tighten, SWIFT’s role in limiting Russia’s financial firepower is becoming clearer.
What role does SWIFT play in economic sanctions against Russia?
The invasion of Ukraine by Russia has generated international condemnation. On March 12, the US and the EU, along with the UK and Canada, agreed to exclude seven Russian banks from the SWIFT system, thereby disrupting their ability to operate globally.
At the time of writing, however, this measure did not affect Sberbank (the most prominent Russian bank) or Gazprombank, through which European payments for Russian oil and gas imports are processed.
Implications of this exclusion
Exclusion from SWIFT stands to have a significant impact on Russia. A country without access to SWIFT cannot process international banking or business transactions quickly or effectively, leading to substantial economic losses.
This is not the first time a country has been excluded from SWIFT. In 2012, Iran was excluded as part of a raft of EU sanctions against the country’s nuclear programme.
Within the space of four years, the country lost nearly half of its revenue from oil exports, along with 30% of foreign trade. Exports fell by 28%, and GDP fell by 7.5%.
The situation for Russia could be similar. According to the Carnegie Moscow Centre, exclusion from SWIFT could affect between 20% and 30% of Russia’s transactions, and could reduce GDP by up to 5%.
Already, it appears to be having significant effects: oil tankers have stopped all export activities, and the Russian rouble has taken a tumble, leading to domestic inflation.
However, Russia’s barring from SWIFT, along with other sanctions, stands to have a wider impact.
The measure could affect the European financial system – one of the reasons some EU countries have reservations about them.
Russia is also an important global energy provider, and many nations rely on SWIFT to pay for fuel imports.
Private companies who do business with Russia also stand to incur huge losses, so their exclusion is not an isolated problem.
Given all of this, what alternatives do Russia (and those who do business with it) have in terms of communication channels for processing transactions?
Alternatives to SWIFT?
In the wake of its annexation of Crimea in 2014, several Russian banks suffered exclusion from SWIFT, so Russia developed its own interbank messaging system known as the System for Transfer of Financial Messages (SPFS).
Although SPFS replicates many of the functions of SWIFT, it is not widely used outside of Russia.
Currently, SPFS connects about 400 domestic banks, for whom it processes about 20% of all domestic money transfers, but it connects to very few Western financial institutions.
The SPFS system also has several limitations, including message size and operational hours, in contrast to SWIFT’s 24/7 service.
Nevertheless, Russia’s recent exclusion from SWIFT could give new urgency to initiatives designed to resolve these problems.
China has also developed its own cross-border interbank payment system called the Chinese Cross-Border Interbank Payment System (CIPS).
Backed by the People’s Bank of China, it has often been mooted as an alternative to Russian banks in case of disconnection.
Already, 23 Russian banks have joined CIPS. However, it is still not popular (processing less than 2% of global payments, which is around 0.3% of SWIFT transactions).
However, CIPS could potentially become a regional alternative to SWIFT, especially in Eurasia, which will be useful if China suffers sanctions in future.
Interestingly, in 2019, several central European countries (France, Germany, UK, Belgium, Denmark, the Netherlands, Norway, Finland, Spain, and Sweden) launched the Instrument to Support Trade Exchanges with Iran (INSTEX) as an alternative to SWIFT.
INSTEX is currently confined to humanitarian trade though, which is permitted under US sanctions.
Conclusion and future alternatives
In both the short and medium term, it’s fair to say that SWIFT will continue to be the leading interbank communication system for global transactions, which is bad news for Russia or any other country affected by economic sanctions.
However, given the existence of alternatives, it will be interesting to observe their evolution in light of ongoing geopolitical tensions.
Much of their future development will no doubt depend on how much actors like Russia and China feel incentivised to decouple from a system that the West fundamentally manages.
Of course, there are other options. Many banks affected by current or future sanctions may also turn to digital currencies, which use blockchain technology to bypass the need for third-party verification.
In my next blog, we will discuss this exciting innovation.
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