“Apply this economical, peaceful, silent and deadly remedy and there will be no need for force.” After World War I and the subsequent establishment of the League of Nations, President Woodrow Wilson used these words to describe the impact of sanctions. Of course, times have changed.
After the invasion and annexation of the Crimean peninsula in 2014, Russia was the target of many such sanctions. And now, after a full-scale invasion of its neighbor Ukraine from February 24, Russia has again been hit with coordinated sanctions from the United States and the European Union, among other nations. US sanctions included export controls, direct sanctions on military and political targets, and financial sanctions against two of Russia’s largest banks: Sberbank and VTB Bank. Edward Fishman, the Obama administration’s former Russia sanctions chief, reportedly said, “I was part of the team that designed the sanctions in 2014, and that’s way beyond what we had. considered”. As Russian troops have continued to pour into neighboring Ukraine, Woodrow Wilson’s optimism about sanctions may not apply to Russia.
In response, on March 2, the European Union played what was touted as a trump card: banning seven major Russian banks from the SWIFT payment messaging network. According to the announcement, VTB Bank, Bank Otkritie, Novikombank, Promsvyazbank, Bank Rossiya, Sovcombank and VEB Bank had seven days to stop using SWIFT from the announcement.
The Society for Worldwide Interbank Financial Telecommunication, to give SWIFT its full name, is an organization that oversees the world’s first international payment messaging system. Although SWIFT does not directly manage clearing and settlement procedures, it is responsible for conveying messages about how payments should be made and received, and it is used by more than 11,000 financial institutions worldwide. A SWIFT ban on Russian banks essentially prevents them from transacting cross-border – unless they want to communicate via clumsy email or telegram.
Nevertheless, financial isolation will fail to deter Russia’s military ambitions. In fact, Russia was not totally unprepared for such an occasion. In particular, Russia has engaged in various “de-dollarization” efforts, which have focused heavily on cooperation with China. First, Russia has developed its own domestic alternative to SWIFT, known as the Financial Message Transfer System (SPFS). It is possible that SPFS will be integrated into China’s nascent, but much larger, payment system, the Cross-Border Interbank Payments System (CIPS). Second, Russia has prioritized the use of the Chinese renminbi for international trade and payment purposes.
In the past, Russia’s former finance minister predicted that Russia’s exclusion from SWIFT would lead to a 5% drop in its GDP. So how have things changed? Can Russia’s growing use of the RMB and its connectivity to CIPS mitigate this magnitude of economic fallout?
In response to Western sanctions against Russia following the 2014 invasion of Crimea, Russia established SPFS, a regional alternative to SWIFT. The Russian central bank estimates that there are more than 400 participants on the network. While most of these member banks are located in Russia, many are also found spread across the former Soviet Union. By the end of 2020, the platform was performing communications for around a fifth of all domestic banking transactions.
On its own, SPFS will fail to provide an adequate replacement for SWIFT. This is why, as early as 2016, Russia advocated plans to integrate its systems with that of the Chinese CIPS. Supported by the People’s Bank of China, CIPS was launched in 2015 to support the internationalization of the RMB. This system is significantly larger than SPFS: CIPS processed approximately $12.68 trillion in transactions in 2021. By the end of the year, CIPS reported that 1,280 financial institutions in 103 countries and regions were connected to the system.
Of course, CIPS is far from replacing SWIFT itself. While CIPS aims to operate independently in the future, it is still working closely with SWIFT in order to gain access to its wider network. Specifically, the flow of funds goes through the CIPS at the national level, while the flow of information in international transactions has been handled by CIPS or SWIFT. Moreover, accounting for only 3.2% of international transactions, the RMB has yet to provide a strong argument for many global banks to join an RMB-based financial messaging network.
Would SPFS-CIPS collaboration be sufficient to cushion the impact of a SWIFT ban on Russia? China is Russia’s largest trading partner in terms of exports and imports. In 2021, Sino-Russian trade jumped more than 30% to an overall value of $146.9 billion. Bilateral trade between these countries has increased by more than 50% since the initial barrage of Western sanctions against Russia in 2014, and current sanctions could increase Russia’s dependence on the PRC.
RMB-based trade accounted for around 28% of Chinese exports to Russia in the first half of 2021, up from just 2% in 2013, showing Russia’s ambitions to de-dollarize. Hampered by the low convertibility of the RMB, it will be difficult to increase the share of trade in RMB; however, Russia’s high proportion of RMB foreign exchange reserves and a bilateral strategic swap agreement with China should allow this percentage to increase.
Ever since Russia first invaded Ukraine in 2014, the country has been busy stockpiling foreign reserves. While Russia’s central bank will not be able to tap reserves held in Western countries due to sanctions, it can still use the 13.1% of its reserves – amounting to $77 billion – which are held in RMB, which can help facilitate international trade.
For additional liquidity, Russia can also tap into its long-standing bilateral swap agreement (BSA) with the People’s Bank of China. A BSA, or Currency Swap Agreement, gives a beneficiary party the right to exchange currencies with a counterparty at a fixed rate of interest. BSAs are often used both to reduce the risk of currency fluctuations in times of financial volatility and to promote cross-border trade. Russia dipped into its swap agreement between October 2015 and March 2016, and Russia’s central bank noted that the funds were allocated with the aim of “supporting bilateral trade and direct investment between the two countries”. The current situation could encourage Russia to use this line of credit more.
Overall, with only a third of its global trade with its largest trading partner settled in Chinese currency, and due to the limited SPFS and CIPS member networks, Russia is far from being able to international trade without SWIFT. Russia can use its foreign exchange reserves and outstanding BSA to increase its share of RMB-based trade; however, this cannot happen overnight and, in the short term, it will not meet the needs of a globally connected Russia.
Importantly, the EU sanctions that strategically removed seven Russian banks from SWIFT did not include Russian banks that process energy-related payments. Russia is one of the world’s leading exporters of oil, among other energy products, and energy exports account for more than 25% of the country’s total. Western reliance on energy-efficient Russian banks like Gazprombank, which make payments for Russian oil and gas, and that will leave Russia with at least a lifeline to rely on while other sectors of the economy will begin to collapse.
Russian oil and broader RMB-based trade could help mitigate some of the immediate impacts of the SWIFT ban. However, while significant media coverage has highlighted the increased reliance on China as a solution to a SWIFT ban for Russia, regional integration between SPFS and CIPS will not provide an adequate alternative. Until the internationalization of the RMB continues, this network would not be able to meet Russia’s international trading requirements. Even more worrisome for Russia, China might not even have any intention of integrating the SPFS into CIPS in order to avoid getting entangled in punitive actions from the West, rendering all this debate pointless.