Some prophylactic remarks. First, even banking plumbing experts are in fog of war mode about what the announcement over the weekend, that some Russian banks, including Russia’s central bank, were to be blocked from SWIFT…but workarounds would be made so that the West could still buy oil and gas from Russia. As our Clive, who has been trying to puzzle out what this means (recall Clive is an IT specialist for a UK TBTF and his brief has him involved in operational and regulatory matters), said,

Russia excluded from SWIFT is the headline…

https://www.gov.uk/government/news/joint-statement-on-further-restrictive-economic-measures-26-february-2022

… but “selected Russian banks” allows plenty of wriggle room…. the reporting is unforgivably vague so it’s difficult to parse as to what’s mooted here in this particular measure….

I think even the “professionals” are doing nothing more than amateur musings right now, to be honest ?

Second, the McCarthyite escalation is resulting in anyone who fails to fall in with a simple “Putin/Russia are the new Satan” line as being depicted as a Russia apologist. That utterly impedes taking a clinical look, as best as one can, at the positions of two parties and what their interests and moves might be.

For those who have been around this site for a while, you may recall that during the 2015 Greece bailout negotiations, we concluded very early on that Greece would not prevail, based on its limited options, such as its need for continued bailouts, it having signed an agreement in February 2015 that committed it to implement the IMF “memorandum,” aka “reforms,” aka hairshirt, and the practical impossibility + huge downside of trying to launch its own currency, that it would have to submit to the Troika’s program. Far too many readers took that as siding with the financiers rather than the plucky Greeks, as opposed to a clinical assessment. The vitriol got so bad that we had to turn off comments for a while.

And not only were we proven right, but the Troika made the terms harsher because prime minister Alex Tsipras held a referendum that violated Greek law for how one was to be conducted¹…..and on a moot issue, on a bailout that had already expired and procedurally could not be brought back from the dead.

We have far more risk of being wrong here than in 2015 because there are vastly more moving parts plus emotions in the West plus as Clive intimated, we are in a fog of poor quality information.

On top of that, the Mighty Wurlitzer is stoking emotions to a fever pitch. This is dangerous because it will limit flexibility and tend to, in fact is arguably designed to, produce overreactions. It is also depressing to see such outrage in the US over Russians killing Ukrainians, when we’ve seen virtually none over our nation-breaking in the Middle East and our support of the Saudis in their campaign against Yemen. The Chinese pointed out that those who live in geopolitical glass houses should not be throwing stones.

As Frederick Douglass said,

I shall feel myself discharging the duty of a true patriot; for he is a lover of his country who rebukes and does not excuse its sins. It is righteousness that exalteth a nation while sin is a reproach to any people.

Back to SWIFT.

Clive has quite a few concrete ideas about how this could work operationally and what this might imply regarding intent. But let’s look at this from a 50,000 foot level.

Commentators contend that one aim in freezing Russia’s central bank out of SWIFT is to make it unable to use its dollar reserves to defend Russia’s currency. Related to that, one way for Russia’s central bank to provide dollars to Russian banks who might need them to settle at the end of the trading day would be to swap roubles for dollars or need dollars to pay off net short term dollar debt exposures if they can’t roll the debt.

Yet the press reports all state that the West intends to have carveouts so that Western concerns can still buy oil and gas from Russia.

I don’t understand why Russia should go along with this. If I understand the economic proposition here, the West wants Russia to continue to take dollars for energy…which it won’t let it spend. Why not just give Russia a bag of feathers for its valuable oil? They’d be just as useful.

Clive independently came to a similar conclusion:

It’s not, I don’t think, intended to stop Russia selling exports. Certain exports, such as some natural gas, will be allowed, well, because Germany, at least in the short-term. It’s more to stop Russia from buying imports. Almost immediately, no-one will trust they’ll get their money if they sell to Russia, they’ll want cash up-front. So that creates a fairly instant working capital crunch — importing businesses in a Russia will need to send the funds for their purchases first and then, and only if their transaction goes through, will the overseas exporter even think about shipping the goods, doubly so if the seller wants US$s. Not a problem for cash-rich Russian businesses but a big, possibly fatal, problem for wobbly ones, unless their bank is willing to extend them a line of credit. But that line of credit will be, in effect, a US$ (or other ForEx) line of credit, Russia won’t want to waste scarce US$ liquidity on basket-case domestic business who are at risk of default.

And there’s a not small chance that, as the bank of the company buying goods to import into Russia will need to get its hands on ForEx to remit overseas to the seller, it’ll potentially need US$ clearing.

Now right now, Russia really has its hands full, by design, and may not be able to make sober calculations. The rouble was down roughly 30% versus the dollar at opening but according to Reuters, but stabilizing after a massive hike of interest rates, from 6.5% top 20%, plus central bank intervention:

The Russian rouble slid more than 15% against the dollar and euro at market opening in Moscow on Monday but central bank intervention arrested its fall, after it tumbled to a record low in Asian trade as harsh new sanctions were slapped on Russia.

At 0800 GMT the rouble was trading at 95.48 to the U.S. dollar , down 15% from Friday’s close, and at 107.3550 per euro , 15.4% lower, with central bank selling of foreign currency set to limit its losses in Moscow trade. It had earlier touched a record low of 120 to the dollar on electronic currency trading platform EBS.

It is over my head as to how the Russian central bank can be intervening to prop up the rouble v. the dollar if its dollar reserves are frozen, as some press reports claimed, and it can’t access SWIFT, which one would think it needs to settle its trades. Those who are expert in payments systems plumbing can no doubt clarify, but either the SWIFT interdiction hasn’t been fully implement and Russia’s central bank is getting in under that wire, or there is a meaningful gap between media accounts and what is actually happening.²

Now that isn’t to say that things are calm in Russia. Clive sent this and warned that the source (NBC) meant it had to be taken with a fistful of salt. But he said it was entirely plausible that Visa and Mastercard would be worried about their exposure, particularly given the lack of detail.

My hotel in Moscow asked me to settle the bill early because they aren’t sure if credit cards are going to work once SWIFT sanctions kick in.

— Raf Sanchez (@rafsanchez) February 26, 2022

Per Clive:

Even if CC payments aren’t technically blocked from Russian card-issuing banks, overseas (outside Russia) merchants probably won’t want to take a chance, now. The scheme’s authorisation code is normally a copper-bottomed guarantee of merchant settlement. But there’s exceptions in the scheme rules where this claim on the issuing bank can be overturned (short version is, you can’t assume you can get blood out of turnip).

Or, as here, Russian merchants similarly won’t want to risk card payment settlements not being routable.

There are also reports of long lines at ATMs in Russia. As a result of the 1998 banking crisis, many Russians prefer the “bank of the mattress” to the regulated kind. But I had also been told by expats who had lived in Russia (admittedly more than a decade ago) that Russian banks offered dual currency accounts (roubles and dollars). If so, anyone with an operating brain cell would be pulling out their dollars out of fear of them being frozen and/or force converted to roubles at a lousy rate. Small businesses would be highly motivated to cash out any dollar holdings. Recall that when the Greek banking system was effectively shut down by the European Central Bank, importers were driving euros across the border to buy inventories, and in one well-publicized case, a Greek importer even flew euros to London.

Having said, keeps some other facts in mind:

Russia is indeed a long way to being a autarky. It’s hard to find data reported consistently across sources, but Russia’s import/export sector looks to be roughly half as big in GDP terms as that of the US (anyone with some decent data and any corrections, please pipe up in comments). China is its #1 source of imports. More detail from OEC:

The top imports of Russia are Cars ($11B), Packaged Medicaments ($10.2B), Vehicle Parts ($8.21B), Broadcasting Equipment ($6.75B), and Planes, Helicopters, and/or Spacecraft ($4.81B), importing mostly from China ($47.1B), Germany ($30B), Belarus ($13.4B), United States ($9.21B), and Italy ($8.79B).

So assuming the SWIFT kick in the head sticks, Russia could presumably devise work arounds for China and Belarus. India depends on Russian fertilizer and there are already worldwide shortages:

Since it’s Russia that’s sanctioned, opening up INR accounts for Russian counter- parties and netting off payables in INR will be easier ( it’s a simple question of crediting the requisite amount of INR to these accounts per settlement cycle).

— Mandar Kagade (@MandarKagade) February 28, 2022

And along the same lines, from the Economic Times:

India is exploring ways to set up a rupee payment mechanism for trade with Russia to soften the blow on New Delhi of Western sanctions imposed on Russia after its invasion of Ukraine, government and banking sources said.

Indian officials are concerned that vital supplies of fertilizer from Russia could be disrupted as sanctions intensify, threatening India’s vast farm sector.

But let’s go back to the point made early on: why should Russia sell its very valuable oil and take dollars when the West won’t let most/all of Russia use dollars for much of anything (at least if we are to believe the press)?

The simplest play would be for Russia to refuse to sell energy under these terms. You either trade with us or you don’t. Embargoes on sensitive items are understandable, but not de facto shutdowns with only the stuff you really need to buy carved out.

Another route is to default:

Given all going on, not biggest issue, but Russia will probably make ruble inconvertible, freezing their markets (& any foreign investments), & might technically default (or worse) on foreign currency bonds

That’s gonna hit trading books. In 98 something similar bankrupted LTCM

— Chris Arnade ? (@Chris_arnade) February 27, 2022

It also led to the sale of Bankers Trust to Deutsche. Bankers Trust owned a lot of Russian debt.

Without going into details, despite Russia being in a lot of trouble domestically, it had adequate FX reserves, so the default caught the market by surprise. And as the writeup in Wikipedia suggests, Russia pulled out of that crisis quickly due to high oil prices back then. So as much as the 1998 experience may have scared citizens about trusting banks (hence the stories of large scale withdrawals sound credible), from the official perspective, the results weren’t too bad and in these circumstances, a rinse and repeat might be in order.

As most readers know, Russia and China have been working on systems outside SWIFT. The short answer is they are far enough along to soften the blow a bit but not enough to serve as substitutes. From the Carnegie Moscow Center:

In the medium term, SWIFT could be replaced for domestic purposes with the Russian equivalent System for Transfer of Financial Messages (SPFS), which was set up by the central bank in 2014 and which aims to replicate the functions of the Brussels-based interbank transfer system.

In 2020, SPFS traffic doubled to almost 13 million messages, but the system still pales in comparison with SWIFT. More than 400 financial institutions have joined the Russian alternative, most of which are Russian banks, but key banks operating in Russia such as the foreign UniCredit, Deutsche Bank, and Raiffeisen Bank, and the domestic Tinkoff and Vostochny banks have yet to join…

Internationally, the Russian analogue has had a hard time picking up foreign members to compete with SWIFT’s network of more than 11,000 members, despite Russian officials’ efforts.

Due to the constraints of the Russian SPFS, the Chinese Cross-Border Interbank Payment System (CIPS) has often been suggested as a more realistic alternative for Russian banks in the event of disconnection. The presumption is that due to China’s economic clout, the renminbi has more potential than the ruble to become a rival currency to the dollar internationally.

There is still a long way to go, however, before CIPS could serve as a substitute for SWIFT. The share of the renminbi in international financial markets is marginal: less than 2 percent of global payments, compared with the whopping 40 percent share the U.S. dollar holds, and far behind the euro, the British pound, and the Japanese yen. As a result, the CIPS payment system remains very small: about 0.3 percent of the size of SWIFT. The internationalization of the renminbi is handicapped by the strict capital controls imposed by Beijing out of concern over financial volatility.

Nevertheless, CIPS could become a regional alternative to SWIFT: in Eurasia, for example. The fundamental question is whether Chinese CIPS and Russian SPFS will collaborate on a joint solution, or whether the Chinese messaging system will make the Russian analogue fully redundant. Twenty-three Russian banks have joined CIPS, while just one Chinese bank—Bank of China—is currently connected to SPFS.

As I indicated, the “just say no” to SWIFT entirely is Russia’s cleanest play. The West has effectively admitted it can’t (either practically or politically) take the hit of going cold turkey on Russian energy.

But its leadership may very well not see it due to being caught up with running a war, trying to gin up negotiations, and being up to its eyeballs in financial fire fights.

Update 6:40 AM EST: Clive suggests that the exclusion from SWIFT, even when implemented (which it appears not to have been as of the time of the Russian central bank foreign exchange intervention) may be plenty leaky:

SDN update apparently still being finalised (publicly available summary here https://sanctionsnews.bakermckenzie.com/eu-uk-us-and-canada-announce-further-restrictive-measures-against-russia/)

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 list) this would enable Russia to find workarounds, such as sock-puppet entities in the rest of the world.

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¹ The biggie was that the time between the announcement of the referendum and the vote was much shorter than required. I would have to check my archives but my recollection is that this was not the only deviation from Greek law.

² Some have speculated that the Russian central bank sold gold. That does not fit the available facts. Reuters reported a central bank intervention that was all done by 0800 GMT, meaning within two hours of market opening in Moscow. For the central bank to intervene buy selling gold, it would have to buy dollars…but it’s supposed to be frozen from SWIFT, so how does that work?

Plus the Western press would love to report the Russian central bank selling gold, since that looks mighty desperate.

Another readers suggested an off market gold trade. That seems unlikely because you’d either need one ginormous buyer, or a bunch of not so big ones, and that would seem hard to line up and execute first thing in the morning, before London was even open.

And as important, an off market sale of gold would not look like central bank intervention. The sale would be invisible (at least until Russia updated its accounting for its gold reserves). But the buying would be. It would look like speculators buying rouble because they thought it was oversold.