Iran’s experience signals banning Swift will not work as expected
It was broad financial sanctions and fines, not cutting off access to the messaging network, that had the biggest impact.
Since Russia’s invasion of Ukraine a curious narrative has taken hold: banning Russian banks from the Swift messaging system, a measure announced over this weekend, will somehow freeze the country out of the global financial system. The experience of financial sanctions on Iran suggests otherwise.
The US has applied, and periodically reinforced, economic sanctions on Iran for decades. From 1984 these sanctions largely targeted the Iranian oil industry. However, they were not made comprehensive until 2006, when a series of “targeted financial measures” were introduced to stop foreign banks undertaking financial transactions with Iran.
The US Comprehensive Iran Sanctions, Accountability, and Divestment Act of June 2010 and National Defense Authorization Act of December 2011 banned all US-Iranian financial transactions. The Obama executive order of February 2011, meanwhile, froze the US assets of the Government of Iran, the Central Bank of Iran and of all Iranian financial institutions. The EU, as a somewhat reluctant partner to US financial sanctions, froze the assets of Iran’s central bank in January 2012. Other countries followed suit.
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. Further indication comes from the fact that it’s given only 11 lines of text in a comprehensive 100-page review of the Iran sanctions put out by the Congressional Office of Research.
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.
Iran’s experience shows that asset freezes, transaction prohibitions and fines on any institution helping with evasion of financial sanctions are far more effective than banning a nation from Swift. Indeed, the restrictions on transactions made by the Central Bank of Russia announced this weekend are an important start.
Fines imposed by the US authorities between 2004 and 2019 for sanctions violations, mostly involving Iran, altogether cost western banks almost $12bn.
The inefficacy of a Swift ban is further illustrated by the fact that when, after the signing 2015 Iran Nuclear agreement, Iran’s banks were readmitted to the messaging network, they were still unable to conduct transactions with any major foreign financial institutions due to the other sanctions.
There was another curious feature to the focus on banning Russia from Swift. Berlin in particular was initially reluctant to go along with the plan, fearing that doing so would make it impossible to pay for the Russian energy upon which it heavily relies. This is especially strange, since energy companies have excellent workarounds already in place. For instance, Germany could simply pay one of Gazprom’s ten active subsidiaries, according to LEI Search, in Europe, instead of the Russian company itself. Avoiding the ban in the process.
Money is as money does. As long as it is not actually illegal, banks around the world have strong financial incentives to help clients get around sanctions. Effective financial sanctions need a legal framework, with associated penalties, in order to ensure that the compliance departments of banks block opportunities for making money from payments to sanctioned entities. As was the case for Iran, this is the best course of action to take if the West is serious about cutting Russian money out of global finance.