Swift’s Sticking Power

Despite emerging alternatives, the network power of Swift makes it tough to remain in the global financial system and avoid sanctions.

Until the war in Ukraine, the financial messaging network Swift (Society for Worldwide Interbank Financial Telecommunication) was only known to payment nerds and the more than 11,000 banks in 200 countries that use it every day to securely transmit messages pertaining to financial transactions. 

In addition to wide-ranging economic sanctions, cutting Russian banks off from the financial messaging network—“de-Swifting”—is the West’s tip of the spear against Russia. In March, the European Commission (EC) announced that seven banks, including Russia’s second largest bank, VTB, would be de-Swifted. Then in May, as part of the EU’s sixth sanctions pack-age, the EC announced that Russia’s largest bank, state-owned Sberbank, would also be cut off.

The Institute of International Finance (IIF), estimates that close to two-thirds of Russia’s banking system, in asset terms, will have lost access to Swift once the EU’s sixth package is implemented. Given Sberbank’s size and importance in Russia, cutting it off from Swift is potentially “game changing,” says Nicolas Véron, a senior fellow at Brussels-based economic policy thinktank Bruegel. But the EU continues to buy oil and gas from Russia, he adds. That means the EU is unlikely to deSwift all Russian banks.

Plus, European banks can still transact with Sberbank, so long as the messaging pertaining to those transactions isn’t transmitted via Swift. Banks could communicate via fax, for example, but it is more cumbersome. 

David Sacco, a practitioner in residence in the finance department at the University of New Haven, says the West is engaged in a delicate geopolitcal “dance with the Russian banking system.” 

“We have this lever [Swift] we can use, but we can’t completely cut Russia off from the dollar banking system because the consequences would be severe,” Sacco says, pointing to the potential to spark civil unrest. “But we need to continue to point out to them that we can use Swift.” However, such weaponization of Swift in geopolitcal negotiations continues to stoke debate among countries  such as Iran, China, Venezuela, and India as well as Russia:

Should they seek alternatives to Swift explicitly to diminish its power to cut them out of the global financial system? 

Central bank advisor Philippe Tissot believes the recent sanctions could strongly encourage Russia, and other countries, to accelerate gateways between digital currencies, sapping the power of the Swift system. “The consequences on the global financial system, whose mission is to manage financial flows, would be to accelerate the implementation of CBDCs and cryptocurrency exchanges,” he said shortly before cryptocurrencies went into freefall, alongside other risk-based assets.

But with close to 12% of the Russian population (17 million individuals) possessing crypto wallets, the second-highest share globally, it is a scenario not too difficult to imagine unfolding. The IIF expects “crypto-related issues [to] gain in importance as financial sector sanctions weigh on Russia’s ability to conduct cross-border transactions,” it wrote in a June note. 

Before the war, Russia’s central bank planned on banning crypto assets. Now the IIF says it is preparing to legalize and regulate them, and is expected to issue its own digital ruble by the end of the year. The IIF says the decentralized nature of blockchain technology and crypto cur-rencies could help Russia avoid sanctions. 

However, these digital tools are available to all, not just Russia. “Blockchain can be used by incumbents as well as disruptors,” Véron says. “Swift could offer a service using this new technology as much as anyone else.” 

Yet, cryptocurrencies are unlikely to provide a satisfactory alternative as the  US and EU have sought to close any crypto-based loopholes in sanctions. Secondly, according to the IIF, the global crypto market is insufficient as a channel for broad sanctions circumvention due to its volatility and relatively small market capitalization, which slumped under $1 trillion for the first time recently.

Alternatives Under Construction

Following the deSwifting of seven Russian banks back in March, Venezuelan president Nicolas Maduro told Telesur, a Latin American terrestrial and satellite television network: “Fortunately, we don’t run bank-ing with the Swift system. We are happy not to operate a banking system dominated by countries that promote destabilizing actions in other nations.”  Venezuela runs bank transactions with its own digital cur-rency, the Bolivar, Maduro added. 

In light of the sanctions imposed by “unfriendly countries,” Russia’s cen-tral bank is also  ramping up efforts to connect additional international partners to its System for the Transfer of Financial Messages (SPFS), which routes transac-tions between Russian banks without using Swift’s infrastructure. As of March 2018, an estimated 400 banks (mostly Russian) were believed to be connected to SPFS, while 23 foreign banks from Armenia, Belarus, Germany, Kazakhstan, Kyrgyzstan and Switzerland are said to have joined the system in 2020. 

The Indian government is considering a proposal to use Russia’s SPFS for rupee-ruble-denominated payments. Iran, also cut off from Swift, is also reportedly mull-ing Russia’s alternative messaging system. There is talk of similar agreements with China, and the Eurasian Economic Union. 

However, in a June 1 note on Russian sanctions avoidance, the IIF states that, “the specific jurisdiction of the payments messaging is somewhat beside the point; the real issue is the US’s and EU’s abil-ity to punish institutions for interacting with Russian counterparts and, underly-ing that, the ability to track transactions.” It seems there is no easy escape from the long arm of sanctions from the West.

Moreover, building a system on par with Swift’s is not so straightforward. “It’s not just about having a messaging service to rival Swift,” says Gerard DiPippo, senior fellow in the Economics Program at Washington-based think tank, the Center for Strategic & International Studies (CSIS). “You need a settlement or clearing service that is not reliant on the dollar. You would also have to build, he adds, “a non-US dollar ecosystem that has a strong network effect.” 

No such system currently exists. He calls Russia’s SPFS “measly” compared to Swift. And while China is making strides in fostering cross-border use of the renminbi—its renminbi-based Cross-Border Interbank Payments System (CIPS) the-oretically could serve as an alternative to Swift and Western clearinghouses—DiPippo estimates that 80% of the trans-actions on CIPS continue to message through Swift, for convenience. 

“The value of Swift is that everybody uses it,” says Véron. “You may use an alternative system, but if the rest of the world doesn’t follow you, you lose that network effect.”

Furthermore, CIPS doesn’t insulate users from sanctions. “US detection capa-bilities are pretty good, and banks are aware of that,” DiPippo says. “There is nowhere to run if you want to be connected to the international financial system.”

The withdrawal of Visa and Mastercard from Russia also raised expectations that China’s main card scheme, UnionPay, would easily step in and replace them. But no evidence has emerged so far. “By and large China is mindful of complying with sanctions,” Veron says. “We haven’t seen anything to support the view that it is willing to disconnect itself from the global financial system to increase finan-cial integration with Russia.” 

Perhaps the only factor that could chal-lenge the global financial system and the market infrastructures like Swift that sup-port it, is reduced dollar dominance. That’s unlikely, at least in the near term. “We are seeing a marginal realignment towards smaller currencies,” says DiPippo. “But the only thing that could unseat the dollar is if the US screws up by letting inflation go nuts, or it defaults on treasuries. However, I can’t imagine a scenario where a bunch of regional currencies displace the dollar. There’s still the network effect.”