After days of hesitation, on February 27, 2022, The United States, EU, U.K., and Canada have agreed to remove select Russian banks from the SWIFT messaging system, one of the biggest sanctions placed on Russia yet. Considered a “financial nuclear weapon”, the Swift system will seriously affect the Russian economy and people, but countries around the world will also be affected.
How the SWIFT System Works
If you want to transfer money overseas, you can walk into a bank and transfer money anywhere around the globe, but how does this actually happen?
Behind most international money transfers is the Society for Worldwide Interbank Financial Telecommunications (SWIFT) system. Founded in 1973, SWIFT is an independent enterprise, based in Brussels (Belgium) that serves as an internal messaging system between more than 11,000 banks and financial institutions in over 200 countries and territories
SWIFT doesn’t send money itself, but it makes transfers possible by communicating information, like where money is going. Currently, with no other globally accepted payment solution, SWIFT is considered the backbone of world finance. Only in 2021, SWIFT record an average of 42 million FIN messages per day. Average daily traffic grew by +11.4% versus the same period in 2020.
Why is SWIFT important to countries?
Cross-border financing refers to the process of providing funding for business activities that occur outside a country’s borders. It is critical to every part of the economy, including trade, foreign investment, remittances and the central bank’s management of the economy. When a country is excluded from SWIFT, all of these sectors suffer severe consequences.
Previously, Iran has twice been removed from SWIFT, first in 2012 over the country’s nuclear program ambitions and again in 2018, over persisting nuclear concerns. Both times, Iran’s oil exports dropped by more than half. Its economy has struggled ever since. The impact on Russia would be equally devastating because energy exports account for more than half of the nation’s total exports.
North Korean banks have been barred from the global messaging network in 2017 as concerns about the country’s nuclear program and missile tests grow, but they manage to get by relying on trade deals with neighbouring China.
Russia’s economy in crisis
According to Russian National SWIFT Association (ROSSWIFT), Russia is ranked second by the number of SWIFT users after the United States. Currently, about 300 leading Russian banks and organizations are users of SWIFT. More than half of the Russian credit organizations are represented in SWIFT. Every day, Russian financial institutions handle about $46 billion worth of foreign exchange transactions, 80% of which are denominated in U.S. dollars.
Moscow’s exclusion SWIFT means Russian banks can no longer use it to make and receive payments with foreign financial institutions. They are nearly impossible to send money into or out of Russia. It is making harder for Russian companies and their foreign customers – especially oil, coal and natural gas importers. In addition, it would also prevent Russia from importing key technologies such as semiconductors and machinery for its own industries. The sanctions could also limit Russia’s use of more than $630 billion in foreign exchange reserves to counter the economic impact. The size of the Russian economy will shrink by 5% after being excluded from the SWIFT system.
West also considered the SWIFT option in 2014, when Russia invaded and annexed Ukraine’s Crimea and backed separatist forces in eastern Ukraine. Russia declared then that kicking it out of SWIFT would be equivalent to a declaration of war. After all, they shelved the idea back then. Russia since then has tried to develop its own financial transfer system, but it’s not great. It connects to only 400 banks or so. However, over the past week, the escalating list of measures is starting to severely impact the country’s economy.
Last week, Russia’s ruble fell by around 30% against the dollar- making it worth less than 1 U.S. cent. People are queuing long lines outside ATMs across Russia, with fears rising over further plunges in the value of the ruble. The central bank doubled interest rates to 20% and imposed controls on payments abroad. The Russian stock market will be closed to trading until at least next Wednesday. Since the last open, Russian stocks listed in London erased more than 90% of their value before getting suspended, global index providers announced plans to remove the nation’s shares from their indexes and European companies with business exposure to the country lost more than $100 billion in market value.
When Russia “sneezes”, the West “catches a cold”
The effort to remove the world’s 11th largest economy and also the supplier of one-sixth of all global goods from the SWIFT system is an unprecedented move in the era of globalization. This development comes in the context of the West having to deal with record-high energy prices in the face of a sharp increase in inflation. So, experts also say that the exclusion of Russia from SWIFT is a “double-edged sword”, not only for Europe, which has close trade relations with Russia and is heavily dependent on gas from Russia, and for the whole world.
Besides in addition to meeting 40% of Europe’s gas demand, Russia also accounts for 10% of global oil production. Many European countries depend on Russia to meet their energy needs, and a sudden inability to buy Russian energy commodities — which have thus far been excluded from sanctions — would cause all sorts of economic havoc across the continent. Energy costs and inflation would rise. Central banks would have to tighten fiscal policy more than they already are.
Russia is also the largest exporter of grains and fertilizers, the leading producer of palladium and nickel, the third-largest exporter of coal and steel, and the fifth largest exporter of timber. If Russia’s access was revoked, they will receive no foreign currency, but Europe will not receive goods, oil, gas, metals and other vital goods. It would be a mess, first of all for its people.
The West’s decision to exclude Russian banks from the SWIFT payment system also has the potential to damage their company and its own banks. Foreign banks have about $121 billion in assets owed to them by Russian-based entities, according to the Bank for International Settlements. Of those, about $14.7 billion were owed to U.S. banks. A larger chunk—$25 billion—were each owed to Italian and French banks. Money owed would be difficult to collect.
Advice during times of financial volatility?
Volatility is back. What should you make of all this? Historically the greatest risk for investors from geopolitical crises has come from overreacting. It is impossible to judge the timing and magnitude of the effects of such events, however, generally, these conflicts have not prevented equities from moving higher over the medium and long term. Investors with longer time horizons should aim to position themselves more defensively to ride out the market’s volatility. In other words, keep an eye out, but don’t panic.
Daily market moves are concerning, but this isn’t the time to switch and ditch stocks, as this can lead to over-trading and capitalizing losses. Diversification offers intrinsic bear market protection. By diversifying across regions, sectors and asset classes, investors can reduce their exposure to risks related to the Russia-Ukraine crisis.
Investing can be emotional, especially during volatile and difficult times. A professional can help manage your portfolio and create a solid, long-term financial plan, taking the emotion out of investing. So, consider speaking with a qualified financial advisor.
