A SWIFT slap on the wrist

During the weekend, there was some real action against Russia and specifically Vladimir Putin. The aim is to freeze Russia's assets, worth around $630 billion, around the world.

‘A global financial pariah’: how central bank sanctions could hobble Russia

The ban on Moscow’s use of its roughly $630bn of foreign reserves will harm [the country's] ability to withstand cost of Ukraine war

The US and its western allies unveiled the most punitive penalties to date against Russia, the latest in a barrage of sanctions rolled out in response to the country’s full-scale invasion of Ukraine. The measures take direct aim at Russia’s central bank and seek to hobble the country’s connectivity to the global financial system. They are intended to destabilise the Russian economy, building on sanctions imposed in recent days that target oligarchs as well as its banks, high-tech companies and aircraft makers.

The thing is sanctions only work if you have the upper hand … and I’m not sure the EU-USA does.

I could talk a lot about the Ukraine crisis, as I have lots of friends in the country. It’s extremely worrying and the motivations, end goal and objectives of Putin are unclear. It also seems like terrible timing as we’ve all had a lockdown for two years and then, to finish it off, Russia possibly starts a World War III. We shall see. However, I don't want to talk about the politics of all of this. I want to talk about sanctions.

There is a call to kick Russia off the SWIFT network and, during the weekend, some parts of the Russian financial system were thrown off the system. Not everything, just some of the biggest banks and the bits that relate most to Putin's personal wealth. The thing is what is SWIFT? How does it work? Can it stop the war?

As I know SWIFT well, I will start with the simple statement that they are the most networked global transaction and messaging system in finance out there today. As SWIFT themselves claim, they are a co-operative of over 11,000 institutions representing over 200 countries, connected to transact and trade seamlessly with trust through their secure network. If you’re kicked out of that network, then you lose access to global trade.

Simon Taylor at 11FS explains it well and his write-up is a must-read to understand how SWIFT works.

1. UK Bank (HSBC) wants to send money to US Bank (Chase).
2. UK Bank (HSBC) sends US Bank (Chase) a SWIFT message "Hey, my customer wants to send your customer £100; I've already converted it to dollars."
3. US Bank (Chase) says to UK bank (HSBC), "Ok, message received, please change the balance of your customer to remove £100 from their account (debit them £100), tell me when that's done, and I'll add $120 to my customer's account"
4. UK Bank (HSBC) sends US Bank (Chase), "I have lowered the balanced (debited) my customer £100, please increase the balance of your customer by $120 (credit them)".
5. US Bank (Chase) sends one last message, "Ok, all done," and at that point, the money has been considered to be "settled" or moved, and the balances change in the customer accounts.

Simon's outline above makes clear that SWIFT is not actually making payments. It is sending messages about payments. That is a core distinction and means that blocking Russia from SWIFT purely blocks the Russian financial system from getting messages about payments in a fast fashion.

Alison Durkee at Forbes adds some good views on why that’s important:

SWIFT, which stands for the Society for Worldwide Interbank Financial Telecommunication, is based out of Belgium and handles payment requests and messages between 11,000 financial institutions across the world, delivering 42 million messages per day in 2021.

The Washington Post likens the system to the “Gmail of global banking,” and the Financial Times notes that while Russia and other countries can still conduct banking transactions with other countries without SWIFT, it would be much more labour-intensive and expensive.

Cutting Russia off from SWIFT would have a significant economic impact: When the U.S. weighed booting Russia from the platform in 2014 due to its annexation of Crimea, former Russian finance minister Alexei Kudrin estimated Russia’s gross domestic product would shrink 5% in a year without SWIFT, and then-Prime Minister Dmitry Medvedev likened the move to a “declaration of war.”

So, what does blocking Russia access to SWIFT mean?

The Financial Times cites that there are 291 Russian members of the SWIFT network representing 1.5 per cent of flows, which makes them the sixth largest country member globally in terms of payment messages sent on the platform. If so, that equates to about $800 billion worth of payments a year or over half of Russian GDP, which was $1.5 trillion in 2020.

The thing is that there are different factions in play here. SWIFT particularly appeals to European and American banks and institutions, but it is not so strong in China, where the Chinese have created their own system. In January 2022, Russia and China announced that they “have agreed to develop shared financial structures to deepen economic ties in a way that will not be affected by pressure of third countries. The move will help both countries reduce the threat of the US government’s long-arm jurisdiction based on the US dollar denominated SWIFT international payment network.”

In other words, there is a business divide here which illustrates that, for all the sabre-rattling in the West, Russia has allies in the East. Only last Thursday, as the attacks on Ukraine began in earnest, the Prime Minister of Pakistan, Imran Khan, was agreeing trade deals with Russia.

Equally, half of Germany’s home are heated with Russian gas. No wonder Germany is unenthusiastic about throwing the country off the SWIFT network, as it would raise questions about how to get power into German buildings, offices and companies.

Indeed, the failure of the US and UK to persuade the EU to push Russia out of the Swift payments alliance exposed a failure of the west’s own common purpose. Chancellor Olaf Scholz was the main sticking point. He evidently fears that if German utilities cannot pay Gazprom using Swift, the Russian energy giant would turn off the taps. Half of Germany’s homes depend on Russian gas for heating.

Nevertheless, even if thrown off the SWIFT network, payments can be made to Russia by Germany, just not through SWIFT messaging. And that is a critical point. SWIFT is not a payments network but a messaging structure. If Germany can use a different structure, such as Russia's own System for Transfer of Financial Messages (SPFS), then there are ways around such actions.

Then, the core question is not about whether Russia should be blocked by the SWIFT network, but whether sanctions and such actions make any difference anyway? Iran was blocked from the SWIFT network for years. Did it make any difference? Not always is the conclusion.

In one of the most comprehensive studies on sanctions to date, academics examined more than 170 case studies spanning a century of economic measures and concluded that sanctions were partially successful only 34% of the time. Among the most notable failures was the US trade and travel embargo on Cuba, which lasted for more than five decades and achieved none of Washington’s policy objectives. But it does hurt a country’s success. For example, Iran has decided it can face sanctions and blockage from the SWIFT network, but it’s really hurting their economy and well-being.

In light of the support of China and other Asian economies, maybe Putin sees the future of Russia as serving the East and not the West. If that’s the case, severing links to SWIFT and cutting off energy to Germany may be cards he can play … and win. The worrying part of that is that it means he wouldn’t give two hoots about NATO, the USA and Europe and their threats.

Finally, even if sanctions are implemented with hostility, there’s one other card in play. I said to some leaders of countries facing sanctions that they might want to move their currencies into cryptocurrencies. I said this years ago. Maybe, today, that is a card that could also be played. Alternatively, they could switch all transactions to Ripple and other external networks.

Joe Biden’s “sanctions might carry less weight in a country that is taking steps to legalise cryptocurrencies and where digital assets are already widely owned. Typically, nations employ physical workarounds to avoid sanctions, such as Venezuela and North Korea’s use of ship-to-ship transfers of fuel, but digital assets like crypto and decentralized exchanges could become the most effective way to circumvent penalties”.

So, in the end there are four routes to follow to stop Russia's financial network, as summarised nicely by MEP Luis Garicano.

His slides are worth noting:

The world is changing and changing fast. SWIFT and sanctions seem like strong things to wave at Russia but, in reality, it is just part of a mix. The challenge is to find the right mixture to stop Russia or, rather, Mr. Putin's ambitions.