Voice of the Industry

Russia, payment systems, and the law of unintended consequences

Monday 14 March 2022 10:58 CET | Editor: Andra Constantinovici | Voice of the industry

Dr. Leo Lipis, Chief Executive of Lipis Advisors, offers a lucid account of the ways in which the EU and US must pay attention to the loopholes the Russian banks can use to bypass some of the economic sanctions, now that it’s more important than ever for them to take effect in discouraging the military campaign.

Amidst anti-war protests around the world, the calls to ban Russia and Russian banks from SWIFT and other financial messaging networks have puzzled many who are not payments professionals. Friends ask me what SWIFT is, how it works, and what effect it will have on the Russian economy and ordinary citizens. People simply don’t understand. 

As the horrific humanitarian crisis unfolds because of this misguided, unnecessary, and tragic invasion, what was once an operational detail deep inside the international financial system is now being used to create some of the strongest economic sanctions the world has ever seen. The consequences of these sanctions will be far-reaching and have vast unintended consequences for payment systems and the stakeholders — chiefly financial institutions and market infrastructures — that operate and use them.

During the week of 28 February, seven named Russian banks were excluded from participating in the SWIFT network. In addition, Visa, Mastercard, and American Express have all announced that they will cease operations in Russia. Trade in Russian sovereign bonds has been suspended and the Russian central bank’s assets frozen. This prevents the normal implementation of monetary policy. 

International condemnation has been rapid and unified (although not as united as presented in the European press). Russian President Vladimir Putin has called the sanctions an act of economic warfare. The president of the Russian central bank, Elvira Nabiullina, wore black when announcing raising interest rates to 20% to defend the value of the Rubel and discussing the impact on the Russian economy. Many payments actors have been caught in the middle.

The law of unintended consequences operates in mysterious ways. Sanctioned banks will look toward alternative financial messaging networks, such as China’s Cross-border Interbank Payment System (CIPS). Russia’s domestic card network, Mir, and the Chinese international card scheme, China UnionPay (CUP), will compete for domestic card traffic. These alternatives are inferior substitutes. Together, CIPS and the fledgling Russian network carry less than 0.5% of the total value of payments made via SWIFT. They simply don’t have the reach or global trust that the well-established players enjoy. These developments will weaken SWIFT, Visa, Mastercard, and American Express as the default global standards for cross-border payment transactions. They could also make cryptocurrencies, which are largely unregulated in most jurisdictions, more attractive for circumventing sanctions.

There are also rumors that regulators elsewhere, particularly in Africa and South America, may use the sanctions against Russia as a justification for mandating the domestic processing of transactions. The entire situation has highlighted the need for mitigating sovereign risk. Last but not least, one presumes that the payments companies that are suspending their business activities in Russia will have to let go most of their local staff. These people could strengthen Russian payments alternatives, whether established players or start-ups.

Unsanctioned entities, both from the financial and non-financial sectors, will look for workarounds. Reports have circulated about correspondent banks from Mongolia that use sanctioned Russian banks for processing foreign currency payments, presumably in EUR or USD. These banks will now have to find other correspondents to handle their payments. Corporates will look to unsanctioned banks to handle their payments. Unsanctioned banks may face difficulty finding correspondent banking counterparties willing to do business with them. Both types may establish shell companies or use creative ruses to circumvent sanctions. The sanctions do allow for payments related to certain types of trade (chiefly oil and gas for a limited period of time). It is unclear how banks are to distinguish permitted payments from those that could be subject to punitive fines. Banks domiciled in countries enforcing the sanctions will have a compliance headache if they choose to do business with any Russian-owned or controlled entities. 

Banks risk stiff fines for non-compliance. US authorities have fined at least 36 banks for a total of more than USD 16 billion for sanctions violations since 2010. They will have to increase their due diligence on any entity linked to Russia or cut ties to the country completely. Inevitably, innocent companies will be caught in this net because it is exceedingly difficult to sort out good from bad players, and good from bad payments. The problem is not like finding a needle in a haystack; it is like finding a needle in a stack of needles. They all look alike.

Any attempt to intensify the economic sanctions regime will also involve payment systems. By closing loopholes, eliminating carve-outs to hit Russia’s important energy sector even harder, and extending the list of sanctioned individuals and entities, the international alliance to contain Russian aggression will likely increase pressure on the payment system as well as Russia. And it should. In the absence of direct military involvement, these economic sanctions are one of the best options available. The unintended consequences are a price worth paying.


About Dr. Leo J. Lipis 

Leo Lipis is the founder of Lipis Advisors and has over 25 years of experience in payment systems management, consulting, and research on all six continents. Prior to founding Lipis Advisors in 2007, he held positions in payments strategy and analysis at with commercial banks, clearing houses, and central banks. Leo works chiefly in transaction banking, payment system strategy and design, and treasury management.

About Lipis Advisors 

Lipis Advisors is focused solely on the payments industry and has been integral to the payments conversation since 2009. Lipis Advisors has completed engagements for more than 200 clients on topics ranging from payment product and marketing strategy, payment system analysis and design, operational improvement, risk management, regulatory compliance, payment fraud management, and many other topics. Equally, at home in consumer and corporate, retail, and wholesale markets, Lipis Advisors cover all players: banks, payment processors, payment institutions, and the payment software and hardware communities.

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Keywords: Russia Ukraine War, financial sanctions, online banking, SWIFT, Visa, MasterCard
Categories: Payments & Commerce
Countries: Asia, Europe, Russian Federation
This article is part of category

Payments & Commerce