What exactly is the SWIFT banking system? (2023)

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Listener Jared Evans asks:

What is the SWIFT banking system? How would countries remove Russia from it? What effect would that have?

The European Union announced Wednesday that it will bar seven key Russian banks from using the SWIFT financial messaging system and may exclude more depending on Russia’s future actions.

SWIFT, which stands for the Society for Worldwide Interbank Financial Telecommunication, allows banks to relay information about financial transactions to one another.

The Russian banks, including Bank Otkritie, Bank Rossiya, Novikombank and VTB Bank, will be barred from SWIFT as of March 12.

Russia launched its full-scale invasion of Ukraine last week, leading to at least 227 civilian deaths and prompting 1 million people to flee the country. In response, nations around the world have imposed sanctions against the country.

Investments in projects co-financed by the Russian Direct Investment Fund will also be banned, and euro banknotes will not be provided to Russia, according to the EU. The RDIF is a sovereign wealth fund, although the U.S. Treasury Department says it’s “considered a slush fund for President Vladimir Putin and is emblematic of Russia’s broader kleptocracy.”

The EU said the sanctions it’s taken against Russia, which include the SWIFT ban, will lead to “massive and severe consequences” for the country.

How does SWIFT work?

SWIFT, headquartered in Belgium, went live in 1977 and replaced telex machines, noisy typewriter-like devices that used phone circuits to send written messages.

Now, more than 11,000 financial institutions across more than 200 countries and territories use SWIFT. Last year, an average of 42 million SWIFT messages were sent per day.

Banks in the SWIFT system have a code or number, made up of 8 to 11 characters, that identifies who they are.

As the payment operations platform Modern Treasury explains it: Say you want to send a wire transfer through SWIFT to someone living in Tokyo. To make that payment, you’ll need a slew of information, including the amount being sent and the Japanese bank’s SWIFT code. Your bank will send that information, and once the receiving bank gets that information, it will deposit the money.

“Later, the two institutions will settle the payment, which means they’ll adjust the account balances to reflect the transfer,” Modern Treasury says.

It is not a system that clears trades, said Paolo Pasquariello, a finance professor at the University of Michigan.

“It is just a system by which financial institutions communicate with each other,” Pasquariello explained.

However, he said SWIFT is important because when banks are transferring money to other banks, they need to communicate to the other party with certainty about the amounts being sent (along with other pertinent information).

SWIFT is used for 70% of transfers in Russia, according to Reuters.

“The fact that these [Russian] banks now are excluded from SWIFT means that these banks cannot use this almost instantaneous communication device in order to talk to banks outside of Russia,” Pasquariello said.

What effect will the SWIFT ban have?

Experts say transactions will become more difficult, but they won’t be impossible.

Randall Henning, a professor of international economic relations at American University, said that this ban does not mean that Russian banks are barred from “accessing international markets or dealing with Western banks.”

But what this will do, he explained, is raise the cost and increase the time involved in making these transactions.

Pasquariello and Henning said banks can still pick up the phone or send a fax, but that comes with complications.

For example, “now you have to pick up the phone and somebody with an Italian accent has to speak English with somebody with a Russian accent,” Pasquariello said.

This turns what was “a near-frictionless transaction” into one with the potential for misunderstandings, errors and delays, he added.

Pasquariello said before he became a professor, he worked in finance, and every time he made a trade, his phone calls with brokers and dealers had to be taped.

“Lawyers on either side had to listen to my weird conversations over the phone when I spoke English with an Italian accent,” he said.

Pasquariello said they were confirming information like the price that they had agreed upon.

“SWIFT makes sure that this information is quickly and precisely communicated to both parties” he noted.

Some banks will not be banned from SWIFT

Reuters reported that the EU’s SWIFT sanctions will not apply to banks that handle energy payments, a decision that has received backlash from government leaders such as Polish Prime Minister Mateusz Morawiecki.

“As Poland, we demand that all Russian entities, thanks to which Russia finances the war in Ukraine, be effectively and fully covered by sanctions,”Morawiecki said on Facebook.

Henning explained that Western Europe isn’t willing to do this now because of its reliance on Russian natural gas and oil.

“Once they have made … changes to energy policy and found alternative sources for energy, then they can begin to ratchet back their dependence on Russian oil and gas,” Henning said.

More than 40% of the EU’s natural gas supply comes from Russia.

“The reality is that it’s really difficult to overhaul an energy system overnight. You just can’t,” Nikos Tsafos with the Center for Strategic and International Studies told Marketplace last week.

Pasquariello said that the EU does “not want to use all the financial weapons at their disposal” in one fell swoop, although it may ban these banks from using SWIFT in the future.

Does Russia have a workaround for SWIFT?

This week, the Central Bank of Russia said it will replace SWIFT with its System for Transfer of Financial Messages, or SPFS, established in 2014.

“It remains to be seen whether this is a solution to their problem or not. It’s unlikely to reduce the cost of dealing with Western banks and other institutions,” Henning said.

Marketplace reported that China’s cross-border interbank payment system, also known as CIPS, is one potential alternative to the SWIFT global payments system.

“China’s CIPS connects participants inside China and out to do trade or investment, and then settles those transactions using Chinese yuan,” explained Marketplace China correspondent Jennifer Pak.

However, Pak said that while “it’s feasible in theory,” it’s not in practice — yet. That’s partly because the Chinese currency isn’t as popular as other currencies. In January, only 3% of global payments on the SWIFT network were in Chinese yuan.

Other sanctions include a freeze on assets from Russia’s central bank held in the United States and a ban on technological exports to Russia.

We’re already starting to see the effects of these sanctions. The Russian ruble’s value has declined to a record low, while people in the country have rushed to ATMs to withdraw money.

Pasquariello pointed out that while some financial institutions can technically still do business with their Russian counterparts, even though they’ve been cut off from SWIFT, they may be reluctant to anyway.

“Whether it’s via phone or via fax,” he said.