Just as it is very hard to tell what is really going on on the military front in Ukraine, so too it is hard to judge what is really happening on the financial sanctions front in Russia. A key point that is not well reported is that the SWIFT block against Russia is leaky. Yet all of the financial analyses I have seen so far presume that the SWIFT ban lives up to its billing, and I have yet to see any commentary based on the instructions to banks and how those affect various customers.

As Clive grumbled:

The whole “block access to SWIFT” is an inaccurate misnomer and really should itself be banned. If the US disconnects Russia from SWIFT (stops routing SWIFT transactions from inside Russia) but does not “blacklist” (put nulls into entries corresponding to the banks in scope on the SDN [Sanction Designated Names] list) this would enable Russia to find workarounds, such as sock-puppet entities in the rest of the world.

Recall that the intent is not to stop Westerners from taking on more dollars by letting Russia sell fuel and other commodities; it is to prevent Russia from using dollars, in particular having its central bank use its FX horde to support the rouble. But that begs the question of why Russia should accept more dollars when the intent is to turn them into useless chits. The most sensible response would be for Russia to sell commodities outside the West and Europe. China is very long dollar FX reserves which are largely an economic dead weight. How about a fuel discount for dollar intervention futures?

Several sources have opined that it should be possible to evade them to a fair, even considerable degree, through cutouts. However, figuring out how to navigate won’t happen overnight, and even then, how much can go through convoluted routes may indeed be more restricted. And a central bank often needs to move too much too fast for any of these cute circuitous routes to do much good.

And Clive’s reading yesterday and today has been confirmed in the Financial Times. From Iran’s experience signals banning Swift will not work as expected:

It wasn’t until March 2012 that Iranian financial institutions were kicked out of Swift. That the US waited this long to push for a Swift ban tells us it was simply not a priority….

The reason ejecting Iran from Swift was never a priority is because, as long as there were third-country banks based outside the US willing to help with workarounds, a ban would have little effect.

Swift is a messaging system, not a payment system. Unlike the payments themselves, messages can be sent by many different routes. In the case of Russia, banks could use its own transfer system, the SPFS (Sistema Peredachi Finansovykh Soobscheniy), which was established after the 2014 invasion of Crimea by the Central Bank of Russia.

This system is increasingly used by domestic banks for cross currency payments within the Eurasian Economic Union — made up of Russia, Armenia, Belarus, Kazakhstan and Kyrgyzstan — and Russia claims it accounted for 17 per cent of Russian international payments messages in 2020. It is also used by some Russian bank subsidiaries in Germany and Switzerland. Russia could also use the Cross-Border Interbank Payment System, or CIPS, network created in 2015 by the People’s Bank of China for the purpose of cross-border payments in renminbi. CIPS features indirect participants in many countries. All these systems — Swift, SPFS, and CIPS — have the same architecture based on the global payments messaging standard ISO20022.

Rerouting through these alternative systems is simply “plug and play”, provided you have a member bank willing to plug you in. Mastercard and Visa systems could also be used for payment transfers. At a pinch they might even use WhatsApp if they are confident in its security from hacking.

Clive adds:

The article gets a bit confused (as often happens) between the massaging aspects of money transmission and the accounting settlement. Both are needed. It is quite correct, as it does in the piece, to say that any messaging system (you could indeed use Instagram) will do, in going down that rabbit hole, it ends up back in the “banning Russia from SWIFT” misclassification.

It completely omits how the accounting gets done and how that, once an entity is SDN’ed, is where the problems for the country which is subject to these measures start.

As soon as the NOSTROs of the bank concerned are identified and blocked, it’s game over in terms of being able to execute the remittance. So what’s proposed to replace those? You can use the shadow banking system to set up accounts and hopefully keep them hidden. But sooner or later, you have to interface to the legitimate banking system (assuming you’re dealing with a legitimate parties as buyers or sellers) and then you start to show your kahoonas.

Even more narrowly, the big noisemaking about crippling the Russian central bank was jarringly at odds with it bein able to do a large FX intervention Monday morning, big enough to halt and partly reverse the plunge of the rouble. But as Clive said:

It’s a long walk between policy announcement, legal certainty and system changes. Unless everyone has coded up and implemented the new policy, Russian Central Bank US$ sell / rouble buy trades will still be being accepted (although it’ll start to get hit and miss).

In the meantime, our Clive provided more technical detail, which you’ll find at the first footnote.¹ The key item is governments need to identify SDNs, as in those “Sanction Designated Names”. And even when you have them, implementation is not as tidy as you might imagine. Again from Clive:

Atlantic Council, so you too can test your barf reflex as I did, but I decided to send it in the end as an illustration that there is still a bit of a gap between policy creation and the nitty-gritty of policy implementation:

(1) As I explained on Saturday, the joint statement hinted at limited sanctions against the CBR. Not blocking sanctions (i.e., asset freeze and transaction ban), but something more scalpel-like to prevent the CBR from undermining other sanctions. https://t.co/Im27PluFz7

— Eddie Fishman (@edwardfishman) February 28, 2022

I really, really object to the use of the phrasing “scalpel-like” here. This can be very valid for SDN’ed individuals. It is much more problematic if we’ve had to SDN entities. SDN’ing entities, when those entities are major money-centre banks, is a very blunt instrument. Once wielded, it can’t easily be unwielded in a hurry. Transaction processing in SWIFT don’t just come to a juddering halt, SDNs get unwound. Unwinding takes several days to a few weeks and re-winding them, if the entity is inappropriately SDN’ed not much less time.

Where the financial sanctions are biting pronto is at the retail level. From Reuters:

U.S. payment card firms Visa Inc (V.N) and Mastercard Inc have blocked multiple Russian financial institutions from their network, complying with government sanctions imposed over Moscow’s invasion of Ukraine….

The government sanctions require Visa to suspend access to its network for entities listed as Specially Designated Nationals, a source familiar with the matter told Reuters. The United States has added various Russian financial firms to the list, including the country’s central bank and second-largest lender VTB….

Russians rushed to ATMs and waited in long queues on Sunday and Monday amid concerns that bank cards may cease to function, or that banks would limit cash withdrawals.

So far, I have not read that ATMs are running out of cash or that the size of ATM withdrawals has been limited. Russia might have higher levels of physical currency relative to GDP than advanced economy norms due to Russia’s 1998 financial crisis leading to a certain fondness for the Mattress Bank.

As Lambert pointed out, Moscow was foolish enough to make ApplePay a mode of payment, and since ApplePay is an interface over a Visa/Mastercard back end. So that no longer being operative also results in long queues to pay in cash.

As we pointed out yesterday, Russia does have a strictly domestic card network. But is is nowhere of the scale of Visa and Mastercard. Wikipedia states that there were 100 million Mir cards issued as of October 2021. Russia has roughly 100 million adults, but that doesn’t mean the cards are evenly distributed.

If Wikipedia is accurate and these are cards rather than mere individual accounts, that’s actually a plus. Per Clive:

Having a workable internal network is one thing, but there was nothing to force Russian banks from being scheme members of the internal network and not a huge set of incentives (until last Thursday’s bolt from the blue) for banks and card issuers to become members of the internal network (as opposed to, say being members of the VISA / Mastercard schemes). So some banks will have issued their cards under the internal network, some under non-Russian controlled schemes.

Further complicating matters is the (lamentable) industry trend to issuing virtual cards only (i.e. you don’t get a physical card, you only get a virtual card which you load into your virtual wallet e.g. Apple Pay / Google Pay). Word of advice to anyone — never evah evah evah sign up to a credit or debit (or any other card) which only supports being used via the tokenizers (e.g. Apple Pay). I would have told Putin to disallow that practice for Russian banks, but he never asked. Too late now. Apple and Google have had to block Apple Pay and Google Pay in Russia (their virtual wallets demand geolocation data to authorise a transaction). So even internal network cards which are virtual card only are inop now.

Russian economy will be having to adjust to a fairly substantial cut-over to cash-only. In order to avoid money supply cratering (M0 / MB) causing a similar collapse in the velocity of money, the Russian Central Bank will need to have the means of increasing the availability of physical cash (which is both the notes and coins in the vault and the ability to get them into circulation i.e. ATM capacity / replenishment logistic / tellers at banks and the like). That’s for roubles. If people end up de facto dollerising, that’s out of their hands.

Needless to say, most Russians can forget about travel even if they wanted to go to, say, Turkey. It’s going to be extremely messy to carry that much currency, even assuming being able to convert roubles. However, the Russian become substantially dollarized during the early 1990s rout and only since about 2000 was the rouble seen as a decent currency. Most (all?) banks offer dollar accounts. It’s a reasonable guess that the big ATM withdrawals over the weekend were first of dollars. It would seem less likely that the Visa/Mastercard freeze was as widely anticipated.

Reuters reports that crypto sales to rouble buyers are way up even as Urkaine is calling for Russian crypto wallets to be seized. From LiveMint:

Vice Prime Minister Mykhailo Fedorov said on Twitter that he was asking “all major crypto exchanges to block addresses of Russian users.” He had earlier solicited information about digital wallets associated with Russian and Belorussian politicians, saying that the Ukrainian crypto community was ready to offer a “generous reward” to anyone who provided tips.

PlutoniumKum pointed out that Euros could also serve as currency:

While we focus on dollars for obvious reasons, I wonder how many large denomination Euro cash bills are sitting under Russian beds just awaiting this type of emergency. Given its ease of use across the large land border between Russia and Europe, I wonder if these notes will become the de facto emergency currency.

As a reminder, not everyone thinks that the West lowering the dollar hammer gives it the winning hand. For a contrasting view, an article we posted in Links by staunch Tory and Russiaphobe Ambrose Evans-Prithcard argues that Russia’s large market share in many key commodities will enable Russia to deliver more pain to Europe than it can inflict on Russia.

Needless to say, in theory we could know more over the next week, but the reporting in the West is so focused on depicting the Russians as weak and failing that the risk of yet again underestimating Russia’s current capabilities remains a big part of the equation.

_____

¹ From Clive:

The technical requirement is to take the source control file (HTML version here https://ofsistorage.blob.core.windows.net/publishlive/UKSL/UKSanctionsList.html) and do an xml translation against the core systems to map the Sanctioned Designated Name against any product holdings (bank accounts, card PANs, wealth management portfolios… a big list even just for retail, a lot more convoluted for trading) so you can apply block flags to prevent transaction processing (or whatever treatment is applicable).

U.K. government has updated with Friday’s list, https://www.gov.uk/government/publications/the-uk-sanctions-list but still waiting for the new list (Sunak inflicted a load of invective and huffing and puffing on us all just now https://www.gov.uk/government/news/uk-statement-on-further-economic-sanctions-targeted-at-the-central-bank-of-the-russian-federation when all we wanted to really know, in terms of the industry trying to do their bidding as they want us to do not parse a load of politicking, was where the bloody SDN is):

The UK Government will immediately take all necessary steps to bring into effect restrictions to prohibit any UK natural or legal persons from undertaking financial transactions involving the CBR, the Russian National Wealth Fund, and the Ministry of Finance of the Russian Federation. The UK Government intends to make further related designations this week, working alongside our international partners.

It’s the designations (the updated SDN) we are waiting for which is why I’ve highlighted that bit, the rest is piffle. Once we have the SDN, the xml translation is easy peasy lemon squeezy as a systems change. The yucky bit is processing (a manual job) the resultant report the core systems generate where there’s partial matches or a lot of de-duping to work through to make sure you don’t block the wrong party (unfortunately it does happen, Mrs. Jones at number 47 The Larches getting flagged as an international terrorist when she uses her debit card at Sainsbury’s) but don’t miss anyone you want to block.

A week, maybe a little less, this is top priority, once we get the SDN. (can’t emphasise that last point enough).

Other institutions may take longer. We’re pretty hopeless but this is BAU (albeit a big change by BAU standards), to be fair there has been a little thought by governments as to how we can as a practical matter turn their policy into real-world execution. This method allows some granularity by repurposing a system (SDN) to upscale it across a large swathe of pretty huge entities while allowing exceptions within those entities. The original “cut Russia off from SWIFT” was the kind of dumb thing politicians say when they are blissfully ignorant of how those of us who have to make their dreams a reality are suppose to do that.