Why SWIFT is the financial ‘nuclear option’ when it comes to punishing Putin

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Millions of times a day, bankers key a unique 11-digit code into their computers, instantly sending encrypted instructions to their counterparts across the globe to complete a financial transaction.

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Financial institutions and entire economies have come to rely on the co-operative network with a cumbersome full name —  Society for Worldwide Interbank Financial Telecommunications. Better known as SWIFT, it is part of the fabric of the global financial system, processing more than 40 million messages per day between 11,000 institutions.

Before it existed, transferring funds between banks was a complicated and error-prone task, involving line-by-line instructions in whatever language was required by those on either end of the transaction.

“It really is the difference between a rocket ship to the moon and a horse and buggy,” said Clifford Sosnow, a partner at Fasken Martineau DuMoulin LLP and chair of the law firm’s international trade group. “If we don’t have that platform, our economy is just not going to function.”

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Now, excluding Russia from the network is being advocated as the West’s financial “nuclear option” in its attempt to push back against Vladimir Putin for the invasion of Ukraine.

On Saturday, the leaders of Canada, the European Commission, France, Germany, Italy, the United Kingdom, and the United States issued a joint statement condemning Putin’s “war of choice” and attacks on Ukraine, and committed to ensuring the removal of “selected Russian banks” from the SWIFT system.

“This will ensure that these banks are disconnected from the international financial system and harm their ability to operate globally,” the statement said.

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It is not without precedent: Iran’s banks were ousted from SWIFT following European Union sanctions in 2012.

But Saturday’s statement came after divisive negotiations, with some countries concerned that the banishment of Russian banks from SWIFT would harm their own trade or currencies. It was also viewed as a last resort by some who suggested the move could push Russia into closer alliance with China, both of which have been working on rival financial processing systems.

These alternative systems are more costly, and “clunky” when compared to SWIFT, according to Sosnow. As a result, pushing Russia off the global co-operative network would eat into profits of Russian exports, even if the country is able to cobble together an alternative to handle the bulk of transactions associated with its trade and other banking business.

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“Internationally (there are) not really too many alternatives for money transfer,” said Karina Cheplinger, a payments specialist who was part of Bank of Nova Scotia’s international payment operations team until last May.

While cryptocurrency could be an option on a small scale, a lack of regulation and general wariness is likely to blunt widespread uptake, said Cheplinger, who is now director of enterprise procurement and vendor management at Symcor Inc., a payment processing services provider.

“For corporate or commercial purposes, SWIFT represents the most secure and verified method for international transactions because it is global and all participants undergo rigorous due diligence before becoming part of the network,” she said, adding that SWIFT must also abide by several regulatory requirements.

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The global interbank system used to require specialized terminals, some of which remain in the back offices of Canadian banks, but technological advances including encryption mean transactions instructions are now communicated using regular bank computers.

SWIFT has not operated without bumps — including a 2018 hack in which US$81 million was improperly removed from accounts at Bangladesh’s central bank in a matter of hours.

However, it remains an indispensable part of a deeply interconnected global financial system with no easy replacement.

The global co-operative is incorporated under Belgian law, but positions itself as a neutral utility whose shareholders are its users. It is overseen by central banks including those in Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, the United Kingdom, the United States, Switzerland, and Sweden, as well as the European Central Bank.

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When EU-sanctioned banks in Iran were disconnected in 2012, the utility justified the action because it was required to comply with European Union regulations.

Among G7 nations, those that do a lot of trade and financial transactions with Russia, including Germany, were understood to be among the most reluctant to fully disconnect the country’s banks from SWIFT as part of efforts to stop the incursion into Ukraine, which began in the early hours Thursday.  Some in the United States were reportedly concerned that, beyond the economic impact, cutting off participation could diminish the U.S. dollar’s importance as a global currency. 

For Canada’s banks, which are already facing higher compliance costs from sanctions Canada imposed on Russia on Thursday — including a prohibition on doing any business with the country’s seven largest banks — there would be potential headaches from disruption of the system, Sosnow said.

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“Each and every bank now needs to know, ‘okay, who’s sending the money?’,” he said, adding that this involves granular details such as determining every individual, businesses, and financial institutions involved in a transaction, even if they are not specifically among the sanctioned.

“So banks have enormous compliance costs now to comply with those sanctions, and it’s just going to get even more expensive for them,” Sosnow said.

Though the SWIFT system provides tools to help banks detect activities that fall under sanctions, including screening and testing services, it is up to the financial services firms to ensure they are complying with all current sanctions and financial crime laws.

“Every bank, depending on the instructions, needs to do some payment due diligence,” said Cheplinger. “And not all SWIFT senders always provide accurate and complete information when sending a swift.”