Why SWIFT is the nuclear option of Russian financial sanctions

The United States and its NATO allies have rolled out an unprecedented number of sanctions against Russia as punishment for its invasion of Ukraine, including banning exports of cutting-edge technology to Russia.

One measure that Ukraine and some of its allies pleaded for is to cut Russia off from SWIFT, the world’s largest financial transaction network. It’s an option that would sever Russia from most international banking transactions, and potentially cripple its economy for a time.

On Saturday, the US and its allies moved forward with plans to do just that. 

"We commit to ensuring that selected Russian banks are removed from the SWIFT messaging system," the leaders of the European Commission, France, Germany, Italy, the UK, Canada, and the US said in a joint statement. "This will ensure that these banks are disconnected from the international financial system and harm their ability to operate globally."

SWIFT (the Society of Worldwide Interbank Financial Telecommunications) is a financial messaging network used by more than 11,000 financial institutions in 209 countries. Overseen by the G10 central banks, the SWIFT payment network uses standardised, secure codes that allow financial institutions to send and receive information, such as instructions for transferring money across borders.

The SWIFT network is critical for cross-border trading, as it enables businesses in one country to guarantee payment in another country. For example, an EU business buying Russian products must use SWIFT to transfer funds from a local bank to the Russian vendor's bank account using SWIFT's banking codes.

Once Russia is unplugged from the network, its government and businesses would no longer be able to receive payment for goods and services unless Russia establishes secondary measures. Forty percent of Russia’s revenue from oil and gas sales go through the SWIFT network, according to Aseem Prakash, co-founder and Global Futurist at the Center for Innovating the Future, an advisory firm based in Toronto.

“The more [the] US weaponises its currency…or cuts countries off of SWIFT, the more countries will be forced to create or find alternatives. It is already happening. And, most likely, Russia would have looked at those options,” Prakash said before the Saturday move was announced.

Using the global financial network as a sanctions weapon could undermine confidence in the US dollar and SWIFT as an apolitical network. That might accelerate the creation of alternatives such as trading in local currencies, using cryptocurrency, and forming new bilateral free trade agreements, Prakash said. China, Iran, and India, for example, already trade in local currency.

In 2014, Russia created its own banking network — Transfer of Financial Messages (SPFS) — in response to threats of SWIFT sanctions at the time. Russia could also choose the Chinese alternative to SWIFT called CiPS — Cross-Border Inter-Bank Payment System. There are plans to integrate SPFS with China’s Cross-Border Inter-Bank Payments System.

Russian President Vladimir Putin might not care about economic hardships caused by sanctions. But Russian banks targeted by them are largely controlled by Russian oligarchs, and Putin likely does care about them. That's one of the main reasons the first round of multinational sanctions rolled out last week targeted the country’s kleptocracy.

Announced on Tuesday by the US and key allies in the European Union, the UK, Canada, Japan, and Australia, those sanctions included “full blocking” of two of Russia's largest financial intuitions — VEB and Russia's military bank, Promsvyazbank, which performs defence deals, US President Joe Biden said.

A Treasury Department statement said VEB is "crucial" to Russia's ability to raise funds, while Promsvyazbank is a critical part of Russia's defence sector. The two institutions and their 42 subsidiaries hold combined assets worth $80 billion, the release said. The Biden Administration said it has also blocked financial transactions from five key Russian oligarchs believed to be "participating in the Russian regime's kleptocracy.”

Even so, cries to cut Russia off from SWIFT grew as Russian troops and hardware rolled into Ukraine and Kiev, the capital. The Ukrainian government had called for Russia to be expelled from the banking system, but the move was seen as such a major step that several nations urged caution.

On Thursday, the European Central Bank, UK Prime Minister Boris Johnson, Canadian Prime Minister Justin Trudeau and Czech President Milos Zeman all called for expelling Russia from SWIFT. Germany, however, warned it and other EU nations had reservations. 

G7 officials said some members were reluctant because it would make it impossible to pay for Russian energy, which could indirectly cause increases in international energy prices, a concern Washington has as well.

“If the West cripples the Russian economy, Russia could turn off the energy supply in retaliation. That will create absolute chaos in Germany which [gets] 65 per cent of its natural gas from Russia,” Prakash said. “If the German economy and society are disrupted, it will have a huge negative impact on the rest of Europe (since Germany is Europe's largest economy).”

Additionally, western banks have hundreds of billions of dollars already in play, particularly in oil and gas futures. There are oil and gas tankers at sea whose cargo was purchased weeks and months ago. Cutting Russia off from SWIFT could leave those purchases unsettled, and it’s the US and EU banks who could be on the hook for that money, Prakash said.

How those purchases would be settled in the wake of the latest sanctions is not yet clear.

Biden asked during a news conference Thursday about the possibility of cutting off Russia's access to SWIFT, said  Europe wasn’t yet comfortable with doing so, which is why it was left out of the sanctions announced that day. Instead, the sanctions expanded financial penalties to all 10 of Russia’s largest banks, its oligarchs, and high-tech sectors, Biden said.

“The unprecedented export control measures will cut off more than half of Russia’s high-tech imports, restricting Russia’s access to vital technological inputs, atrophying its industrial base, and undercutting Russia’s strategic ambitions to exert influence on the world stage,” Biden argued.

The president also acknowledged that removing Russia from SWIFT could affect the EU. “It is always an option, but right now that’s not the position that the rest of Europe wishes to take,” Biden had said on Thursday.

EU President Ursula von der Leyen said the bloc still planned to offer up a package of “massive and targeted sanctions” to European leaders for approval. “We will target strategic sectors of the Russian economy by blocking their access to technologies and markets that are key for Russia,” she said, adding that the EU will look to limit Russia’s “capacity to modernise.”

The EU and the US also went after Putin more directly with sanctions aimed at him and top aides that were unveiled late Friday.

The tech sanctions specifically aim to deny exports of sensitive technology for the Russian defence, aviation, and maritime sectors.

In addition to sweeping restrictions on the Russian-defence sector, Biden said the US government will impose Russia-wide restrictions on sensitive U.S. technologies produced in foreign countries using US-origin software, technology, or equipment.

The restrictions affect semiconductors, telecommunication, encryption security, lasers, sensors, navigation, avionics and maritime technologies and are designed to cut off Russia’s access to cutting-edge technology.

Prakash noted US sanctions on high-tech items do not just include products manufactured by the US firms. The sanctions also ban any product made anywhere that use any kind of US technology (software, sensors, etc).

“Yes, China will be able to fill in some gaps. But, the sanctions are going to hurt the Russian manufacturers that import all kinds of products from different parts of the world,” Prakash said. “They will have to rethink everything — supply chain, payments and factory floor design.”

While semiconductors are relatively easier to control through supply chains because there are a relatively small number of companies producing them, restricting sensors or software involves a different calculation.

“Complying with and enforcing sanctions, globally, will be tricky for general purpose high-tech products,” Prakash said.

Along with financial sanctions, the EU announced it would ban the export of certain technologies as a move to weaken Russia’s ability to modernise and hinder its long-term economic growth.

“The wild card in all of this is of course foresight,” Prakash said. “How much and how far did Russia see all of this and plan for it?”