SWIFT ban explained: How the messaging system works

SWIFT justice

The war in Ukraine and consequent moves to sanction Russia have put a spotlight on SWIFT as an integral part of the global payments system, but what part? Analogies abound, each more confusing than the last: It’s the “Gmail of global banking,” it’s Twitter for banks, it’s a thermostat system.

The most common description of SWIFT is a messaging system for payments orders, not a medium for moving money. But modern money is just data entries in bank accounts. You need messages to transmit that data. And SWIFT is a database of financial institutions. If you insist on a software analogy, it’s Microsoft Outlook, Exchange and Active Directory.

SWIFT is modern, but it reflects a banking system that dates back to Italy of the late medieval period. Italian banks gave birth to the Western financial system, which is why you run into the terms “Nostro” and “Vostro.”

• “Nostro” means “our” money — an account owned by Bank A and held by Bank B — while “Vostro” is “your” money — an account held by Bank A and owned by Bank B. From Bank B’s perspective, of course, “Nostro” is “Vostro” and “Vostro” is “Nostro.”
• When a client of Bank A wants to send money to a client of Bank B, the banks exchange payment orders on SWIFT. Bank A debits the client’s account and credits Bank B’s “Vostro” account. Bank B mirrors the transaction on its ledgers, debits the “Nostro” account and credits the client.
• There’s a huge amount of money in “Nostro” and “Vostro” accounts: $27 trillion as by the end of 2015, according to this McKinsey report.
• SWIFT connects more than 11,000 banks and other organizations in more than 200 countries and territories. And not all banks have the right pairings of “Nostro”/“Vostro” accounts for a given transaction, which makes looking up banks on SWIFT and figuring out the hops money has to take from account to account all the more useful.

Disconnecting Russian banks from SWIFT effectively axes them from this worldwide web of accounts. The accounts are still there, but the hard part is finding them.

• On March 2, the EU penalized Russia by finally agreeing to cut off several major banks from SWIFT. European Commission President Ursula von der Leyen said this would deter Putin’s war efforts by paralyzing Russia’s financial system. The sanctions were later extended to banks in Belarus, too.
• When SWIFT delisted Iranian banks in 2012, the country subsequently lost almost half of its oil export revenues and 30% of foreign trade.
• Banks outside of the SWIFT network could still transact with delisted Russian banks but they would have to rely on a prohibitively expensive, error-prone messaging system of paper, fax and email. Those manual processes could lead to costly, if not fatal, mistakes.

Could Russia adopt alternatives? China and Russia have both been developing their own bank-messaging networks. And the energy business might be key.

• The greatest limitation of Russia’s SPFS and China’s CIPS is the particular currencies they work in, the ruble and the yuan. SWIFT is the place to go for banks doing business in euros and dollars. SPFS has a minimal presence outside Russia, and CIPS ekes out about 1% of the volume of SWIFT.
• The dollar is still the world’s reserve currency and the dominant currency for energy transactions. That’s why bankers and politicians will want to keep an eye on Saudi Arabia, which is reportedly considering pricing oil sold to China in yuan. A yuan-denominated energy market could give Russia crucial support and a way around sanctions.
• The West’s measures are leaky, too. Sberbank, though sanctioned by the U.S., hasn’t been kicked off SWIFT. Germany reportedly resisted this move because of the need to keep paying for Russian oil and gas. Still, Sberbank had to dissolve its European unit in the face of sanctions, so keeping SWIFT access may be a small consolation.

Sanctions will likely tighten over time. The EU issued a fourth round of financial measures Tuesday. Keeping track of who’s safe to do business with will be crucial. In normal times, it’s hard for financial institutions to keep up. SWIFT’s KYC Registry is a crucial tool, which is why kicking banks off SWIFT can have cascading effects. Finding banks willing to hold “Nostro”/“Vostro” accounts will get harder. The SWIFT ban doesn’t just prevent banks from easily messaging each other; it creates the kind of risk and uncertainty in doing business that bankers hate. And that’s the point.

— Leah Zitter (twitter)

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