“Apply this economic, peaceful, silent, deadly remedy and there will be no need for force.” Following World War I and the subsequent creation of the League of Nations, President Woodrow Wilson used these words to describe the impact of sanctions. Certainly, times have changed.
Following the 2014 invasion and annexation of the Crimean Peninsula, Russia was the target of many such sanctions. And now, following a full-scale invasion into its neighbor Ukraine beginning on February 24, Russia has once again been pummeled with coordinated sanctions from the United States and the European Union, among other nations. The United States’ 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 former Russia sanctions lead from the Obama administration, was quoted saying, “I was part of the team that designed sanctions in 2014, and this is far beyond what we contemplated.” As Russian troops have continued to pour into neighboring Ukraine, though, it can only be that Woodrow Wilson’s optimism on sanctions failed to apply to Russia.
In response, on March 2, the European Union played what has been 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 wind down their use of SWIFT from the time of the announcement.
The Society for Worldwide Interbank Financial Telecommunication, to give SWIFT its full name, is an organization that oversees the world’s leading international payment messaging system. While SWIFT does not directly handle clearing and settlement procedures itself, it is responsible for delivering messages on how payments should be given and received, and it is used by over 11,000 financial institutions globally. A SWIFT ban on Russian banks essentially prevents them from conducting cross-border transactions – unless they wish to communicate by clunky email or telegram.
Nonetheless, financial isolation will fail to deter Russia’s military ambitions. In fact, Russia was not entirely unprepared for such an occasion. Particularly, Russia has engaged in various “de-dollarization” efforts, which have been strongly centered around cooperation with China. First, Russia has developed its own domestic alternative to SWIFT, known as the System for Transfer of Financial Messages (SPFS). It is possible that the SPFS could become integrated with China’s nascent, yet much larger, payment system, the Cross-Border Interbank Payment System (CIPS). Second, Russia has prioritized use of the Chinese renminbi for international trade and payment purposes.
In the past, Russia’s former finance minister forecast that excluding Russia from SWIFT would cause its GDP to shrink by 5 percent. So, how have things changed? Can Russia’s increasing use of the RMB and connectivity with CIPS mitigate this magnitude of an economic fallout?
In response to Western sanctions on Russia following the invasion of Crimea in 2014, Russia established SPFS, a regional alternative to SWIFT. The Russian central bank holds that there are more than 400 participants on the network. While most of these member banks are located within Russia, many can also be found spread across the former Soviet Union. By the end of 2020, the platform conducted communications for approximately one fifth of all domestic bank transactions.
On its own, SPFS will fail to provide an adequate replacement for SWIFT. That is why, since as early as 2016, Russia has advocated plans to integrate its systems with that of China’s CIPS. Backed by the People’s Bank of China, CIPS launched in 2015 in order to assist the internationalization of the RMB. This system is significantly larger than SPFS: CIPS processed around $12.68 trillion worth of transactions in 2021. As of year-end, CIPS reported that 1,280 financial institutions in 103 countries and regions are connected to the system.
Of course, CIPS is far away from replacing SWIFT itself. While CIPS is aiming to operate independently in the future, it is still working closely with SWIFT in order to access its wider network. Specifically, the flow of funds works through CIPS domestically, while the flow of information in international transactions has been handled by either CIPS of SWIFT. Moreover, comprising only 3.2 percent of international transactions, the RMB has yet to make a strong argument for many global banks to join an RMB-based financial messaging network.
Would an SPFS-CIPS collaboration be enough to buffer impacts of a SWIFT ban on Russia? China is Russia’s largest trade partner in terms of both exports and imports. In 2021, Sino-Russian trade jumped by more than 30 percent to an aggregate value of $146.9 billion. Bilateral trade between these nations has expanded by more than 50 percent since the initial barrage of Western sanctions towards Russia in 2014, and the current sanctions may increase Russia’s reliance on the PRC.
RMB-based trade accounted for approximately 28 percent of Chinese exports to Russia in the first half of 2021, rising from only just 2 percent in 2013, pointing to Russia’s ambitions to de-dollarize. Hampered by the RMB’s poor convertibility, it will be difficult to increase the proportion of RMB-based trade; however, Russia’s high proportion of RMB foreign reserves and a strategic bilateral swap agreement with China stand to allow this percentage to rise.
Since Russia first invaded Ukraine in 2014, the country has been busy at work stockpiling foreign reserves. While Russia’s central bank will be unable to tap into reserves held in Western countries due to sanctions, it can still employ the 13.1 percent of its reserves – amounting to $77 billion – that are held in RMB, which can help facilitate international trade.
For additional liquidity, Russia also can tap into its longstanding bilateral swap agreement (BSA) with the People’s Bank of China. A BSA, or cross-currency swap agreement, gives a recipient party the right to exchange currencies with a counterparty at a fixed interest rate. BSAs are often used both to reduce the risk of currency fluctuations in times of financial volatility as well as to lubricate cross-border trade. Russia tapped into its swap agreement between October 2015 and March 2016, and the Russian central bank noted that the funds were allocated for the purpose of “supporting bilateral trade and direct investment between the two countries.” The current situation might give reason for Russia to employ this credit line further.
Overall, with only one-third of its global trade with its largest trading partner settling in Chinese currency, and due to the limited member networks of SPFS and CIPS, Russia is a long way from being able to conduct international trade without SWIFT. Russia may employ foreign reserves and its outstanding BSA to increase its proportion of RMB-based trade; however, this cannot happen overnight, and in the near term this will fail to meet the needs of a globally connected Russia.
Importantly, though, the EU sanctions that have removed seven Russian banks from SWIFT strategically did not include Russian banks that handle energy related payments. Russia is one of the world’s leading oil exporters, among other energy outputs, and energy exports account for more than 25 percent of the nation’s total. Western dependence on Russia’s energy saved banks like Gazprombank, which carry out payments for Russian oil and gas, and this will leave Russia with at least one lifeline to rely on as other sectors of the economy begin to topple.
Russian oil and broader RMB-based trade may help to mitigate some of the immediate impacts of the SWIFT ban. However, while significant news coverage has pointed to increased reliance on China as a solution to a SWIFT ban for Russia, regional integration between SPFS and CIPS will fail to provide an adequate alternative. Until further internationalization of the RMB takes place, this network would be unable to support Russia’s international trade requirements. Even more worrying for Russia, China may even lack the intent to integrate SPFS with CIPS in order to prevent entangling itself in punitive action from the West, rendering this whole debate pointless.