How Disastrous Would Disconnection From SWIFT Be for Russia?

The April 29 resolution passed by the European Parliament on excluding Russia from the SWIFT international payment system should its troops invade Ukraine may be legally nonbinding, but it did not go unnoticed by the Kremlin. Presidential spokesman Dmitry Peskov said a potential cutoff was a serious threat, and that its implementation could not be ruled out.

Calls to exclude Russia from SWIFT are not new. In August 2014, the UK appealed to European leaders to consider such an option. Alexei Kudrin, Russia’s former finance minister, then forecast that such a move could cause Russia’s GDP to shrink by 5 percent. Ultimately, the pressure campaign was dropped. Cutting Russia off from SWIFT was considered to be a major escalation, or, as then prime minister Dmitry Medvedev put it, tantamount to “a declaration of war.”

Since then, the likelihood of this nuclear option being implemented has remained low. Russia’s high level of interconnectedness with the West has worked as a shield. The United States and Germany would stand to lose the most if Russia were disconnected, because U.S. and German banks are the most frequent SWIFT users to communicate with Russian banks.

Still, Moscow has taken steps to secure its domestic financial system, with the case of Iran serving as a cautionary tale: after Iranian banks were disconnected from SWIFT, the country lost almost half of its oil export revenues and 30 percent of foreign trade. The impact on the Russian economy would be equally devastating, particularly in the short term. Russia is heavily reliant on SWIFT due to its multibillion exports of hydrocarbons denominated in U.S. dollars. The cutoff would terminate all international transactions, trigger currency volatility, and cause massive capital outflows. Since 2014, therefore, several countermeasures have been introduced to minimize the risks and potential economic damage to Russia.

If Russian banks are disconnected from the Visa and MasterCard payment systems, all domestic transactions could be done through the National Payment Card System. Performing international transfers, however, would be an arduous task.

In April 2014, a number of Russian banks were blacklisted by the United States. Both Visa and MasterCard suspended the targeted banks’ services and blocked them from using their payment systems. The following month, the Russian government passed a new law introducing the National Payment Card System, later known as Mir (“World”). Fully owned by Russia’s central bank, the card system operates as a clearing center for processing card transactions within Russia.

Since 2014, Mir’s share of operations has grown to 24 percent of all domestic card transactions, with more than 73 million cards using the Mir system issued. Its rapid growth stems largely from the fact that in Russia, bank cards are generally issued by the employer (or the state in the case of benefits), and Mir cards are now standard issue for pensioners, public sector employees, and others in receipt of public funds.

Making payments outside of Russia is still far from easy with a Mir card, however. Full services are only available in Armenia and the Russia-backed breakaway Georgian regions of South Ossetia and Abkhazia. Some operations are possible in Turkey, Kyrgyzstan, Uzbekistan, and Kazakhstan. By using cards co-branded with the international Maestro system, Chinese UnionPay, and Japanese JCB, some transactions can be conducted abroad. But it is hardly the global card that its name suggests.

In the medium term, SWIFT could be replaced for domestic purposes with the Russian equivalent System for Transfer of Financial Messages (SPFS), which was set up by the central bank in 2014 and which aims to replicate the functions of the Brussels-based interbank transfer system.

In 2020, SPFS traffic doubled to almost 13 million messages, but the system still pales in comparison with SWIFT. More than 400 financial institutions have joined the Russian alternative, most of which are Russian banks, but key banks operating in Russia such as the foreign UniCredit, Deutsche Bank, and Raiffeisen Bank, and the domestic Tinkoff and Vostochny banks have yet to join. To attract new members, the central bank has resorted to both carrots—slashing the system’s tariffs to about half of SWIFT’s charges—and sticks: in 2019, the Accounts Chamber proposed obliging all banks operating in Russia—including the subsidiaries of foreign banks—to connect to the Russian analogue.

Currently, 20 percent of all domestic transfers are done through SPFS. The central bank seeks to increase this share to 30 percent by 2023. To become an attractive alternative for commercial actors, however, the system would still need to resolve its technical limitations. Operations are limited to weekday working hours, unlike SWIFT, which works 24/7, and the system limits the size of messages to 20 kilobytes.

Internationally, the Russian analogue has had a hard time picking up foreign members to compete with SWIFT’s network of more than 11,000 members, despite Russian officials’ efforts.

Due to the constraints of the Russian SPFS, the Chinese Cross-Border Interbank Payment System (CIPS) has often been suggested as a more realistic alternative for Russian banks in the event of disconnection. The presumption is that due to China’s economic clout, the renminbi has more potential than the ruble to become a rival currency to the dollar internationally.

There is still a long way to go, however, before CIPS could serve as a substitute for SWIFT. The share of the renminbi in international financial markets is marginal: less than 2 percent of global payments, compared with the whopping 40 percent share the U.S. dollar holds, and far behind the euro, the British pound, and the Japanese yen. As a result, the CIPS payment system remains very small: about 0.3 percent of the size of SWIFT. The internationalization of the renminbi is handicapped by the strict capital controls imposed by Beijing out of concern over financial volatility.

Nevertheless, CIPS could become a regional alternative to SWIFT: in Eurasia, for example. The fundamental question is whether Chinese CIPS and Russian SPFS will collaborate on a joint solution, or whether the Chinese messaging system will make the Russian analogue fully redundant. Twenty-three Russian banks have joined CIPS, while just one Chinese bank—Bank of China—is currently connected to SPFS.

Another option advocated for by Oleg Deripaska—one of the Russian businessmen hit by U.S. sanctions—is for the Russian government to speed up the introduction of the digital ruble to ensure cross-border transactions. The introduction of the digital ruble was approved by the central bank in October 2020. Unlike decentralized cryptocurrencies, central bank digital currencies bring back control right where the Russian authorities want it to be: with the state. The first prototype of the digital ruble is scheduled to be ready in late 2021, and is due to be tested in Crimea, which is isolated by international sanctions. Other central banks across the world have similar plans for a government-led digital currency, but Russia has greater motivation: it aims to reduce dependence on the U.S. dollar, boost the ruble globally, and minimize the risk of sanctions.

Yet the extent to which central bank–controlled digital currencies can help to reduce the dollar’s hegemony and mitigate the risk of sanctions is questionable. The digital ruble will be as toxic as the analogue version, and will not be accepted easily as a means of payment outside the country. Digital payments between U.S. competitors and adversaries like Russia, Iran, and Turkey are possible, but would remain on a regional scale.

The ability to fully sidestep U.S. sanctions with the use of digital currencies is also limited. Since March 2018, the U.S. Office of Foreign Assets Control has not differentiated between normal monetary transactions and digital currency transactions when it comes to sanctions compliance. That means dealing with a sanctioned entity or person would still be prohibited. The OFAC has also been exploring new technology-related tools to analyze and track blockchain-based transactions to gather attribution information.

Finally, Russia’s drive to reduce reliance on U.S.-centered payment systems could profit from Europe’s latest efforts to push back against U.S. dominance on the financial markets. Dissatisfied with Washington’s reimposition of sanctions on Iran, the EU launched the Instrument for Supporting Trade Exchanges (INSTEX) as an alternative to SWIFT. INSTEX is currently confined to humanitarian trade, which is permissible under U.S. sanctions. But the desire to counter the pressure of unilateral U.S. sanctions means others are watching the EU’s further steps closely. In the future, the EU plans to improve the effectiveness of INSTEX, and countries like Russia and China have already offered to collaborate on it. The EU is also looking to reduce reliance on dollar-dominated clearing houses and payment cards such as Visa and MasterCard. Much work would need to be done before these initiatives could become viable alternatives. With secondary sanctions, the United States can easily weaponize its financial power against European companies, but the mere idea that the EU is emboldened to create a parallel channel to conventional, U.S.-connected routes is a welcome message for Moscow and Beijing.

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