A SWIFT Kick to the Russian Financial System - The

A SWIFT Kick to the Russian Financial System – The Cengage Blog


Article Summary

  • SWIFT is a global financial communication network from which a number of Russian transactions are now banned
  • Economics teaches us that SWIFT ban workarounds will not be easy to accomplish
  • The SWIFT system ban may be further expanded if EU dependence on Russian oil and natural gas can be reduced

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Michael W. Brandl is a Professor of Instruction in the Department of Economics at the University of Texas at Austin.

This post is a modified version of an article that originally appeared on BrandltheEconomist.com’s Macro Updates blog.

On February 22, 2022, in response to Russia’s invasion of Ukraine, a large collection of nations, including the United States and members of the European Union, decided to selectively ban Russian banks from using the SWIFT system. Suddenly this relative obscure part of the global financial system was cast into the spotlight. So, what is the SWIFT system? Why is it part of the sanctions on Russia? What are the economics involved in banning Russia from SWIFT?

What is SWIFT?

The Society for Worldwide Interbank Financial Telecommunications, or SWIFT for short, is an international financial information system. Before SWIFT came along in early 1970s, banks in different countries communicated with each other through loud, clunky, teletype machines. These machines looked like typewriters on steroids. SWIFT streamlined these global inter-bank communications and created a standard way for banks to communicate with each other.

Imagine that Pryia in Austin, Texas wants to send money to her friend Meghana’s bank account in Tokyo, Japan. Pryia provides her bank with various information about Meghana’s bank account, including the bank’s SWIFT code or number, Meghana’s account number, and the amount of money Pryia plans to send. The SWIFT system doesn’t actually transfer the funds, but it does send very important information about the funds.

Thus, the SWIFT system plays a crucial role in our global financial system. More than 11,000 banks operating in more than 200 countries and territories belong to this member-owned cooperative, overseen by the G-10 central banks. SWIFT processes an estimate of over 40 million messages every business day.

Without the SWIFT system, banks would need to either communicate by phone or some other method. This could be cumbersome and time consuming. Language barriers, time differences, the need to record the conversation in case disputes arise are just some of the sand-in-the-gears that occur if banks do not have access to SWIFT.

 

Access to SWIFT and economic sanctions

Banning banks from using the SWIFT systems has been used as economic sanctions before. In 2012 banks in Iran were banned from the SWIFT system in response to that country’s nuclear development. In 2014, Russia was threatened with being banned from SWIFT due to their actions in Crimea. While the ban was never put in place some argue it shows the importance of the SWIFT system. Without access to SWIFT, the level of international trade a country can engage in may be significantly impacted.

It’s why so many countries in early 2022 banded together to cut off most of Russia’s access to SWIFT. Interestingly however, energy transactions involving Russian banks were still allowed under the sanctions. That was because the EU imports a great deal of the natural gas it uses from Russia. In 2021, the EU imported 45% of its natural gas from Russia. In response to this dependence on Russian oil, on March 6, 2022, the EU announced REPowerEU. This plan seeks to reduce the EU’s purchase of Russian gas by two-thirds before the end of 2022.

 

SWIFT ban expansion

Then on May 30, 2022, the EU voted to expand the SWIFT ban to include Sberbank, Credit Bank of Moscow and Russian Agricultural Bank. The announcement was part of a package that included almost an entire ban on the importation of Russian oil into the EU. The action brings the number of Russian banks banned from SWIFT to ten and includes banks with the closest ties to the Russian government. According to the Financial Times, the ban now covers more than 60 percent of the Russian banking market.

The inclusion of Sberbank on the SWIFT ban list is important. Not only is Sberbank the largest Russian bank based on customers, but it is also the main route for payments of Russian oil and gas. The new sanctions however continue to exclude Gazprombank, Russia’s third largest bank and a subsidiary Gazprom, the Russian government-owned energy company. The bank is the largest facilitator of payments into Russia for exported Russian oil and natural gas.

If the EU successfully ends its dependence on Russian oil and gas, it might make it easier for the EU to expand the SWIFT ban to include Gazprombank. Many experts argue such a move would cause significant damage to Russian exports and by extension greatly cripple the Russian economy.

Why not just create another SWIFT?

Some critics of the Russia ban from SWIFT argue the policy will be ineffective because Russian banks can find ways around the ban, including setting up their own version of SWIFT. To a certain extent, this has already happened. In 2015, the People’s Bank of China launched CIPS (or the Cross-border Interbank Payment System) as an alternative to SWIFT. Two years later the Russian Central Bank launched SPFS (or in English the Financial Message Transfer System) which uses the same technology used by SWIFT and CIPS.

However, neither CIPS nor SPFS have caught on. We economists know why. We call it network effects. For a bank to want to use CIPS or SPFS to send information, the other bank in the transaction also has to use CIPS or SPFS. But, SWIFT has a first mover advantage. As noted above, SWIFT is widely used around the world and has been around since 1977. These two other systems don’t have any significant technology advantage over SWIFT, thus there is little desire for banks to change to the other messaging services. So, getting around the SWIFT ban may not be as easy as it first appears.

It will be interesting to see what impact the SWIFT ban has on the Russian economy, especially if the ban expands to include Gazprombank. It will not be surprising to me if the SWIFT ban does have a significant negative impact on the Russian economy.

Want more information about global financial markets and banks? See Professor Brandl’s textbook Money, Banking, Financial Markets and Institutions, now in its second edition with Cengage.



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