Russia and the SWIFT nuclear option

As images of the tragic human toll in Ukraine start to stream in, many of us and our leaders seek to take effective action. In the quest to restore world peace and order, there have been calls for Russia to be removed from SWIFT. What does that mean, and what are the implications? How effective a sanction can it be?

SWIFT is ultimately an organisation - Society for Worldwide Interbank Financial Communications. It is a not for profit organisation that was set up in the 1970s with the phasing out of telex machines to establish a network of communications, and a standard protocol for the exchange of messages between banks. Mostly these messages were the electronic equivalent of an I-owe-you. They were trusted, for in the banking world "my word is my bond".

These days SWIFT means a few things besides a boardroom of banks. First it is a network. Like the Internet, but separate – parallel, though not as large. SWIFT has its own redundant cables and data centres. You can connect to it via the Internet, but most large banks connect directly. No money goes down those wires, just promises. Second it is a message standard. On a telex there was a certain way to type a payment so that it is very clear who the payment is for and for how much. That technique has evolved to what we have today. Third SWIFT is a synonym for international money transfers (IMTs). The same way "Xerox copy" denotes a photocopy or "Biro" denotes a ball-point pen, SWIFT means an international money transfer. In practice, today 99% of volume of transfers takes place over the SWIFT network, but there are alternative methods to transfer overseas: cash in suitcase, credit card payments, and so on.

Like flight travel before September 11, 2001 (aka 9/11) - security of payments were relatively lax before that time. The G7 set up a Financial Action Task Force in 1989, but it was only 12 years later when the US and the world woke up to an escalated level of threat, that they realised how important it was to secure payments to prevent anonymous funding of terrorist activities. As most payments were on SWIFT, they decided to target those payments. But rather than cutting off the network, regulators required banks report and screen their payments for countries and entities that were on a black list. Each country has a black list that includes entities identified by the United Nations Security Council, allies and the local government. What is unique this time is the sanctions are not UN Security Council sanctions (Russia has a veto vote). Australia's list is here, where you can find recently added Russian entities. The sanctions can be targeted at individuals, banks or nations. And the sanctions apply no matter how the money is sent. Banks that even unknowingly send money without properly declaring or screening them can be fined amounts that rival their annual profits.

The Nuclear Option: Why Governments Should Tread Carefully.

The modern monetary system finds foundation in the Bretton Woods Conference (aka United Nations Monetary and Financial Conference) that took place towards the end of World War II. It was also the final days of perhaps the greatest economist of all time, John Maynard Keynes. Reflecting on his experience, 2 world wars and a great depression, he and others around the table accurately identified a significant causal factor of World War II being the frustration of the Germans after World War I reparations (through the Treaty of Versailles). The economic loss and humiliation fuelled the nation to once again take up arms within just a few years of the previous war. In the final days of World War II, the secret to peace, they felt was a thriving global economy with growth and low unemployment. They could achieve this by using a "World Bank" to help finance the poorest of countries, and an "International Monetary Fund" to act as a buffer for the large countries to help fund recessions. Everyone signed up to it - including Russia, or then the Soviet Union.

“You cannot treat a great nation as if it were a bankrupt company.”

John Maynard Keynes, November 1945

Shutting off Russia from SWIFT - i.e. refusing network messages from any Russian entity, has been called the "nuclear option". Previously the world would have suggested sanctioning of the belligerents. However because these sanctions are not UN sanctions, many countries are not bound by them. The US may pull muscle like it did with their FATCA laws and encourage other countries to comply outside a global treaty (or risk being excluded from the US financial system). However realistically, and in a short space of time, because the SWIFT network is controlled by NATO/US allies, the "nuclear option" may be the easiest solution.

This will have a substantial short term effect on the Russian and global economies. But there are other ways to send payments, other ways to say "I-owe-you": different networks or new networks. Take cryptocurrencies for example. The complicated thing is to make a payment to a Russian entity, the payment settlement does not need to happen in Russia. Not every country has signed up to the sanctions, and bad money can move through the global economy faster than a virus.

The worse outcome is the sanctions are successful, Russia is bankrupted, their people angry and we end up in a similar situation as Germany in 1939. However this time, they literally have a real nuclear option.

These are all serious considerations that regulators and governments around the world are dealing with. Amidst all that is the tragedy of lost homes and lives. Restricting payments may help resolve the issue, however we need to tread carefully.