It would be easier for the readers to start by knowing the definition of the SWIFT system. Therefore, before analyzing the impacts of the exclusion of Russia from SWIFT, it might be helpful to briefly explain what SWIFT is and why it is so important to financial institutions and even the whole global economy. SWIFT system’s role is to carry messages between banks. Although it is involved in the organization and distribution of data, it does so on a store-and-forward basis and does not maintain financial information on an on-going basis; instead, as a data carrier, SWIFT transports messages between two financial institutions.
The main assignment of the SWIFT system is that it’s responsible for providing the platform, products, and services that allow member institutions to connect and exchange financial data, which lead us to say that the most critical part of SWIFT’s role is achieving the secure exchange of proprietary data, reliability, confidentiality, and integrity.
The SWIFT network is jointly-owned by more than 2,000 banks and financial institutions around the world. It is overseen by the National Bank of Belgium, in partnership with major central banks around the world, including the United States Federal Reserve, the European Central Bank, Bank of England, etc.
In some countries, such as Russia, about 300 leading banks and organizations in the country are users of SWIFT, more than half of the Russian credit organizations are represented in SWIFT, and Russia is ranked second by the number of users of the platform, after the United States.
SWIFT Ban on Russian Banks
On March 2, 2022, the United States and the European countries banned major Russian banks from using SWIFT. The Russian banks that mostly affected by the ban are, for instance, Bank Otkritie, Novikom Bank, Promsvyaz Bank, Bank Rossiya, Sovcom Bank, Vnesheconcom Bank (VEB), and VTB Bank
In addition, the western countries have imposed sanction on other financial related instruments; for instance, sanction prohibits the sale, supply, transfer, or export of euro-denominated banknotes to Russia or to any natural or legal person, entity, or body in Russia, particularly the government and the Central Bank of Russia.
The European sanction on Russia avoids main banks that handle Russian oil and gas transactions, such as the country’s largest bank, Sberbank, or Gazprom bank. Since some European countries are still buying oil and gas from Russia, these financial institutions that handle Russian oil and gas transactions are exempted from the SWIFT ban, perhaps for the short term.
However, the United States included all financial institutions, such as Sberbank, in the list of banks the United States sanctioned, as the United States banned the import of oil and gas from Russia and imposed trade sanctions as well. The western countries banned the specific banks because they are closely connected to the Russian government. The ban also extends further to any entities for which these banned banks hold their assets.
How Would SWIFT Ban Impact Russia?
Banning Russian banks from SWIFT freezes their ability to financial transactions both locally and internationally. The SWIFT ban technically impedes the excluded Russian banks from executing their customers’ financial transactions with foreigners, meeting obligations, receiving export payments, or providing short-term import credit. This SWIFT ban paralyzes all Russian economy sectors engaged in trade and finance.
This selective ban has a major immediate economic impact on the Russian economy and its businesses. Indeed, reactions to the SWIFT ban, combined with the actual freezing of the Russian Central Bank foreign assets on February 28, 2022, and the trade sanction by the United States, the immediate result was seen on to the value of the Russian currency, the rubble, decreased about 40 percent. Although, the Russian central bank doubled interest rates to 20 percent and imposed controls on payments abroad.
Also, apart from the international impacts, Russia’s domestic payment system has been disrupted to the extent that all transactions with any card issued by the major credit card financial institutions, such as VISA, Mastercard, Amex, etc, are interrupted. However, Russia has already developed its transaction system known as the System for Transfer of Financial Messages SPFS, which the government has begun to use widely for domestic transactions.
The System for Transfer of Financial Messages SPFS was created after the United States imposed a similar ban from SWIFT following Russia’s annexation of Crimea in 2014. However, only around 25 percent of the domestic card transactions within Russia are transferred through the System for Transfer of Financial Messages. In addition, Russian citizens rely heavily on the SWIFT system when travelling abroad. They find it difficult to use their cards when traveling abroad without access to credit cards using SWIFT.
What Are Risks for the Global Economy?
As a result of the SWIFT ban on Russian banks, there are risks on investors around the globe too. Although the European countries have exempted few Russian banks from the ban, banning Russian banks from SWIFT poses a risk for the world economy as well. First and foremost, it risks disrupting Europe’s energy supply and commodity exports to global markets, triggering further increases in energy and food prices. Prices of oil, gas and many other commodities are already elevated due to supply shortages, adverse weather shocks, and supply chain disruptions. This materially complicates the job of the Federal Reserve and European Central Bank in lowering inflation, which is already running at historically very high levels.
The SWIFT sanctions and other actions could contribute to a default on Russian obligations abroad that could have repercussions on the foreign creditors and bring about a liquidity shock to the United States and European interbank market.
Can Russia Default on Bond Payment
The United States imposed similar sanctions on Venezuela, forbidding trading of the securities in 2019, following a contested presidential election the year prior. The sanction on Venezuela led some of the bonds trade at just pennies on the dollar. The result was the South American nation and its state-oil company, Petroleos de Venezuela S.A., defaulted on a combined 60 billion USD.
Venezuela’s dollar bonds were also removed from the bank’s benchmark indexes in 2019 after sanctions curbed trading. Similarly, some private banks, such as JPMorgan Chase & Co. removed Russian bonds from all of its widely tracked indexes, further isolating the Russian’s assets from global investors.
The potential of Russia committing to its foreign debt payments decreases as bond prices fall, recession looms in the nation, and various payment restrictions pile up after the SWIFT ban.
Investors investing in the Russian bond should be aware that the Russian default on its bond payments is the most likely scenario to happen. In case of default, it is unlikely to be like a normal one, with Venezuela instead perhaps the most relevant comparison.
Russia is like Venezuela because it also has significant oil assets that would only come into play once sanctions are removed. If bonds default and creditors get court judgments, an upside risk would be the ability to access all the assets now frozen outside of Russia, including foreign exchange reserves.
Although North Korea and Iran have long been cut off from SWIFT, as has Venezuela since 2019, Russia’s economy is more complex and sophisticated than these countries, and the financial system is a more integral part of its operation, so the impact of exclusion from SWIFT could have a bigger impact. But countries tend to adapt and find ways around sanctions. Nonetheless, the short-term economic impact of even a partial, but extendable, ban from SWIFT on the targeted country and the willingness by countries imposing the sanctions to bear some economic costs sends a strong signal that can have a sharp economic cost to Russia.
However, excluding Russian banks from SWIFT has also caused permanent damage to international financial integration and the United States dollar hegemony. The success and efficiency of a payment network depend on its widespread adoption and use of its services. When the West implemented a SWIFT ban against Russia in 2014, Russia quickly developed its messaging network to support the domestic payment system. Russia also changed the composition of its foreign reserves away from the United States dollar and strengthened ties with the Chinese Cross-Border Interbank Payment System CIPS, which can settle international claims in yuan.
Russian Seek Alternatives
The SWIFT ban has led not only Russia, but also other countries, such as China, to develop their own parallel international messaging system over the past few years as a precautionary measure against the increased likelihood of the United States and the European countries imposing financial sanctions. Even the European Union countries, at the time of the breakdown of the Iran nuclear deal in 2018, started to develop its financial messaging system, the Instrument in Support of Trade Exchanges INSTEX, to avoid getting trapped in the web of United States imposed sanctions on Iran.
The ban from SWIFT is also encouraged some countries, including Russia and Ukraine, to use cryptocurrencies, for instance, to avoid financial sanctions, as reflected in their unusual appreciation amidst global turbulence on the SWIFT ban.