China has been developing a SWIFT alternative, called the Cross-Border Interbank Payment System (CIPS), which it had hoped would help internationalize the yuan.
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The Society for Worldwide Interbank Financial Telecommunication (SWIFT), established in 1973, is a communication platform that is used by banks, brokerages, and financial institutions to process payments across countries. Each year, SWIFT transmits roughly 10 billion messages between 11,000 financial institutions in more than 200 countries and dependencies, processing trillions of dollars in payments.
The SWIFT system is governed by Belgian and European law, and is overseen by the G10 central banks. Therefore, SWIFT would not be obligated to meet U.S. demands. But Washington could pressure the platform to comply, as it did in 2012, when the United States wanted Iranian banks removed due to economic sanctions.
The United States has tremendous influence over SWIFT because nearly 80 percent of global trade is transacted in dollars and most of those dollars pass through SWIFT, to be cleared in U.S. banks. In order to convince SWIFT to comply, the United States need only threaten to remove its own banks from the system.
The United States is not the only country that has asked to have Russia removed. In 2014, the United Kingdom proposed to European leaders to exclude Russia from SWIFT. And in April 2021, the European Parliament passed a resolution to shut down Russia’s access to SWIFT should its troops invade the Ukraine.
When Russia faced being cut from SWIFT in 2014, then-Prime Minister Dmitry Medvedev threatened that it would be “a declaration of war.” The reason he took such a harsh stance is because Russia’s economy would be devastated if it no longer had access to the international financial platform. It would be nearly impossible for Russia to conduct international business because there would be no way of transmitting across borders.
When Iran was removed from SWIFT, the country experienced difficulty, but not a catastrophe, because it was only somewhat involved with the global economy.
Russia, on the other hand, would feel the effects more strongly as a result of its greater integration with the system. Russia would essentially be unable to sell its exports of oil and natural gas. The ruble would fall and the country would suffer massive capital outflows. Former Finance Minister Alexei Kudrin forecasts that losing access to SWIFT could cut Russia’s GDP by 5 percent.
Although dependent on SWIFT, Russia does have a few options to soften the blow if it was banned from the system. When Russia invaded the Ukraine in 2014, the United States threatened to cut it off from SWIFT. Consequently, the Kremlin called for the development of a domestic financial-communications platform. The System for Transfer of Financial Messages (SPFS), the Russian equivalent of SWIFT, has over 400 member banks across former Soviet republics, handling more than 20 percent of domestic transactions.
The Russian system is far from a replacement for SWIFT. Where SWIFT operates 24 hours a day, 7 days a week, SPFS only works Monday through Friday, during normal Russian business hours. Additionally, the message size is much smaller. Theoretically, SPFS could be expanded and additional foreign countries could be invited to join. But that would take years, and Russia could experience a tremendous economic disruption in the meantime.
Since 2015, China has also been developing a SWIFT alternative, called the Cross-Border Interbank Payment System (CIPS), which it had hoped would help internationalize the yuan.
CIPS may be another possibility for Russia. Due to China’s greater economic importance, the yuan may be a more viable option than the ruble for cross-border trade. However, at present the yuan only accounts for 2 percent of international financial transactions. And CIPS is only 0.3 percent the size of SWIFT. It is possible that the two systems could collaborate; but, so far, 23 Russian banks have joined CIPS, whereas only one Chinese bank has joined SPSF.
Another possibility for Russia is the digital ruble, which is meant to be launched in 2022. This option is also flawed, because, although the currency could easily flow across borders, it will be equally as weak and unstable as the physical ruble. Countries that are outside of the U.S. sphere, such as Iran or Venezuela, may accept some payment in currencies other than dollars, but even these countries would not want the risk of transacting in an unstable currency. Additionally, U.S. law does not differentiate between physical currencies and digital currencies, when it comes to sanctions.
According to Dmitry Dolgin, ING Bank’s chief economist for Russia, “any wire transaction that takes place in the world involving U.S. dollars is at some point cleared through a U.S. bank.” In 2019, Russian President Vladimir Putin and Chinese leader Xi Jinping agreed to find a way around both the U.S. dollar and the U.S.-dominated SWIFT system. The options that the two countries have discussed include de-dollarization, yuan digitalization, and alternative financial settlement and messaging systems, like CIPS.
By 2019, Russia had dumped about half of its dollars, and increased its yuan holdings to 15 percent of its reserves. Working to eliminate the dollar from their bilateral trade, the two countries have managed to get the number down to 46 percent in 2020. Russia increased its euro holdings and is expanding its use of euros for international trade transactions.
Even the euro, however, cannot replace the dollar as the primary international currency, as there are three benefits to the dollar that no other currency offers. First, the dollar generally remains stable in the face of inflation. Next, no country can match the sheer size of the U.S. market or the volume of the U.S. currency. And finally, U.S. financial markets are deep, liquid, and transparent.
The problem for China and Russia is that the U.S. government can deny any entity’s ability to access dollar clearing and dollar settlement. The United States could blacklist large Russian banks and Russian sovereign wealth funds, essentially making it impossible for Russia to transact business in dollars. Russia could begin using euros, but even euro-denominated transactions have to go through SWIFT. And, again, the United States has considerable influence over SWIFT because U.S. dollar clearances account for 79.5 percent of inter-regional currency transactions.
If the United States could convince the Europeans to cut Russia out of SWIFT, the effects on Russia would be devastating. Aside from potentially triggering a war, there would be major collateral damage. Germany would suffer economic loss because of the amount of business they do with Russia. U.S. banks would also take a large hit, as they process the bulk of SWIFT transactions. Europe would also suffer because it is dependent on oil and natural gas from Russia.
Russia is China’s number two supplier of oil, and also a major supplier of natural gas and coal. Even if Russia is removed from SWIFT, the two countries will most likely find a way to continue to trade. This will make Russia even more economically dependent on China, pushing it deeper into the Chinese orbit.