What does the Ukraine crisis mean for payments and the financial system?
The war has major repercussions for cross-border payments and traditional financial networks and correspondent banking relationships. We review the impact of sanctions and the implications for payment flows and global trade
First the shock of Covid-19 and now the conflict in Ukraine. As the war in Europe continues, we are seeing one of the worst humanitarian crises since the Second World War. Short of NATO joining the fight, everything is being done to disable Russia and help Ukraine. Crucially, that includes the systematic exclusion of Russia from international payment networks and banking relationships.
Let’s examine the sanctions to date, the impact on correspondent banking and global trade, and how the conflict could shape the future of finance and payment systems.
Financial sanctions and their impact
Following the invasion on 24 February, the US and EU introduced sanctions packages to prevent the Central Bank of Russia from accessing both its foreign-exchange reserves of more than $600 billion and its National Wealth Fund (NWF).
Next, the focus turned to SWIFT. Despite fears it would damage cross-border trade, several Russian banks were disconnected from the global correspondent banking network at the end of February. Then, on 2 March, SWIFT announced it would exclude a further seven banks from 12 March, plus three Belarusian entities (and their designated Belarus-based subsidiaries) effective 20 March.
Many other punitive steps have been taken across financial services, and some of the biggest names in the payments industry have ceased business in Russia. Visa, Mastercard, American Express and PayPal have all said they are cutting their Russian ties, and money transfer providers Western Union, Remitly, and Wise are among others following suit. In addition, oligarchs and Russian companies have had their assets frozen, while hundreds of western companies such as Apple and IKEA have joined banks and payment providers in exiting Russia.
Collectively, this is one of the most punishing sanctions programmes ever seen. However, given the interconnectivity of global trade and finance, the pain will not be Russia’s alone, and it’s certain that the Kremlin will have planned for sanctions and has ways to circumvent some of the measures.
The impact on supply chains and trade is already being felt, and companies will struggle to find financial channels to sustain markets and maintain business relationships with Russia. Commodities such as wheat, metals oil and natural gas are coming under severe pressure, and the prospect of Russia defaulting on its debts could spread pain worldwide and threaten a liquidity crisis. Again, the danger lies in the complexity and hyper-connectivity of the financial system.
So what is the main impact of removing Russia from SWIFT?
The main impact will be on lower-value payments across smaller business supply chains, and while SWIFT is the bedrock of correspondent banking, excluding Russia is damaging rather than crippling. Moreover, the damage will be shared with Russia’s trading partners and creditors, compounding the disruption to energy supplies and other commodities.
Nor is it certain that financial sanctions will achieve the intended stranglehold. There are alternative channels for Russia, underlining the diversification of payments and a lack of transparency that has long enabled money laundering.
In the fast-evolving world of digital payments, there are many ways to move money to avoid sanctions and it is often difficult to identify underlying relationships when audit trails are convoluted (eg, because of nesting). One positive to emerge from the crisis: illicit money flows are now very much in the spotlight, reinforcing the need for transparency.
Correspondent banking relationships
An indirect impact of the latest sanctions would increase the percentages of termination of correspondent banking relationships and dramatically impact this sensitive ecosystem. The requirements to adhere to the new sanctions will undoubtedly add pressure to a segment already under high pressure of concentration and consolidation. Again, the smaller financial institutions and higher-risk jurisdictions would be affected and cut off from the traditional cross-border chain as they would not be able to evidence product control over compliance requirements.
TenureX can provide all the required information about all the parties involved in a wire transfer as part of redefining correspondent banking services. This means that correspondent banks can assess the risks related to the newest sanction in real-time and maintain cooperative relationships with their current and future counterparties.
Russian banks could use their own payment solution, a SWIFT equivalent that was launched in 2014. Known as the System for Transfer of Financial Messages (or SPFS), this payment network has around 400 users and was developed when Russia was threatened with disconnection from SWIFT when it invaded Crimea.
Although SPFS has significant limitations, Russia could also turn to China’s homegrown payment network, the China International Payment Service Corp (CIPS). A CIPS-SPFS joint payments initiative is a possibility, and the fallout from the Ukraine conflict is an opportunity for China to accelerate its payment ambitions and take SPFS to new regions and counterparties.
Crypto is another payment method that may receive an unexpected boost from the conflict. Although risky and difficult to police, cryptocurrencies have been growing in acceptance as part of the financial system and are a way to operate outside the SWIFT network and traditional finance. However, the infrastructure for cryptocurrencies is mainly suitable for consumer-level payments rather than corporate/government transactions.
Central bank digital currencies (CBDCs), which are similar to cryptocurrencies but issued by a central bank, are also growing in popularity. According to the International Monetary Fund, around 100 countries are exploring the potential of CBDCs, and some are already using them. For example, China has a digital renminbi with more than a hundred million users and billions of yuan in transactions.
Payments in a changing world
The long-term impact of the invasion and any continuing sanctions programme is difficult to predict because of the complexity of global payments and trading relationships. However, the war will certainly have profound financial consequences and will encourage new payment channels, trade routes, and supply chains. The immediate challenge is of course humanitarian: to rebuild Ukraine and restore lives shattered by war.