Not So SWIFT
*Removal of “some” Russian banks from SWIFT has occurred; *The effectiveness of the ban on “some” Russian banks isn't so clear; and *The resultant lack of liquidity exposes Russian bank insolvency.
In response to Russia’s invasion of Ukraine, an entire host of financial sanctions were announced by the United States, European Union, and other western powers. Up until February 26, 2022, the “nuclear option” of a ban on Russia’s use of the international payments system, or the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”), was missing from that list. Finally, the decision was made to remove “some” banks from SWIFT in a bid to further isolate Russia from the global financial system. While SWIFT has previously disconnected all Iranian banks in 2012 for breach of sanctions, this is the first time a major nation’s (formerly G20) financial institutions have actually been removed.
Based in Brussels, SWIFT is a member-owned cooperative financial messaging platform which connects over 11,000 financial institutions and keeps track of and facilitates trillions of USD in cross-border transactions daily in a secure and standardized way. When two banks have a commercial account relationship with one another, the money transfer is completed once the SWIFT message is received. When banks do not have an established relationship with one another, an intermediary bank is used to facilitate the transfer. Half of all high-value cross-border payments from 212 countries are done through SWIFT with an average of 42 mn messages per day. As a major supplier of energy globally, Russia ranks sixth globally in terms of payment messages sent over SWIFT, or second in terms of the number of banks (300) on SWIFT behind the US. As the theory goes, if Russia were cut off from SWIFT the country would essentially be severed from most of the global financial system.
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The effectiveness of a SWIFT ban on Russia is not so clear, however. As a result of the United Kingdom’s campaign to press the European Union (“EU”) in 2014 to block Russian bank use of SWIFT as a sanction over their adventurism in Ukraine/Crimea, the Bank of Russia (central bank) created the Russian equivalent of SWIFT, called SPFS (anglicized ‘System for Transfer of Financial Messages’) which included over 400 member banks (including those from former the Soviet states) and handled 20% of domestic financial communications during 2020. Like China’s version, CIPS (Cross-border Interbank Payment System), it’s small, but together the platforms could provide at least a regional alternative to SWIFT. Blocking Russia from SWIFT could also impact the USD’s dominance as a reserve currency over the longer-term, as this move most certainly pushes the Kremlin even closer to mainland China and to develop a more robust alternative payment system which will ultimately undermine the USD. Mainland China already has its own communication system for trade-related deals in CNY for their local banks.
Further, in response to the previous Ukraine/Crimea sanctions, Russia had begun transforming its various economic metrics. Bank of Russia has shored up F/X reserves to USD 600 bn, or 40% of GDP, which is over 4x the cushion of most European central banks. EUR and gold also represent a greater percentage of reserves than USD, as the USD’s use in trade has sharply declined whilst Russia companies in general have de-levered. Lastly, by only banning “some” Russian banks, or what appears to be a continued wide-ranging carve-out for energy and aluminum trade due to reverberations in global trade, the West has left open the ability for Russia to work around the SWIFT ban for now.
This is not to say that the SWIFT bank won’t impact the Russian economy and financial system. In 2014, Russia’s now former Minister of Finance Alexei Kudron predicted that Russian GDP could contract as much as 5% — although with the aforementioned Russia’s moves that figure may be somewhat overstated today. Russian businesses will find it very difficult to purchase imports and be paid for their exports. Russian citizens, like those in Iran when their SWIFT ban was imposed, likely will not be able to use their credit cards for international payments, forcing massive depositor withdrawals or bank runs. In the most extreme sense, the lack of local bank liquidity could expose the Russian system to solvency concerns with challenged assets needing to be sold at their economic value rather be held at their accounting values.