At a certain scale, companies with enough time and money, tend to strive towards vertical integration. Integrating vertically, controlling a larger part of your value chain, means 1) lower unit costs to produce your goods, 2) better efficiencies along your supply chain, and 3) a better hand on potential disruptions across the chain as they arise. Vertical integration isn’t without its disadvantages, but done right, the upside is usually worth the risk.
This ambition applies not only to goods manufacturers, but service businesses too. The finance industry, in particular, is especially fond of this business, both at the customer-facing level, and the infrastructure level (central banks, clearing houses, etc.).
Just as in manufacturing, if you’re a large bank handling millions of international transactions each week, there’s obvious appeal in wanting to control the rails on which that money moves — or at least making sure your home country’s government does.
When that infrastructure plays a critical role in ensuring stable, reliable trade relations between two countries, it’s probably not that surprising that each of those countries would rather they were the ones who controlled it. Obviously, this isn’t practical — each country can’t really mandate that their trade partners only use their system when trading with them, so a compromise is needed.
Enter SWIFT: The Society for Worldwide Interbank Financial Telecommunication. SWIFT is a service (technically a “cooperative society“) created to serve as a central system by which banks can coordinate international money movements. To avoid the whole issue of a single country controlling this international system, the cooperative is chaired by banking representatives from all over the world. It’s important to note that SWIFT doesn’t actually enable the transfer of funds itself, rather it’s a protocol, a digital messaging language, with which financial institutions coordinate operations of international wire transfers. Banks then operate their internal books based on the messages exchanged over this system.
As a platform for interconnection, SWIFT is a network, and just like any network, its value increases with each incremental new transaction made over it, and each new member that joins it.
Power compounds, and SWIFT has become the de-facto international payment rails for almost all banks across the world.
SWIFT isn’t alone, though. Alternatives exist and have been growing in usage for years.
As Russian banks have found themselves subject to economic sanctions by the US and EU over the war in Ukraine, otherwise boring financial infrastructure suddenly became a mainstream topic of discussion.
Media outlets are often quick to point out that even as many Russian banks find themselves ‘kicked off’ the SWIFT network, they have alternatives that they could turn to to get around Western sanctions. But these alternatives are almost exclusively framed as fallback options — their only role being to let bad actors keep transacting smoothly when the US and EU have turned against them.
To be sure, this is a key feature of these networks. But this framing ignores the thousands of banks already using these alternative networks (usually in addition to their SWIFT-based operations), without the imperative caused by sanctions.
And that’s what I want to explore. When there’s a clear, most effective leader, what are the incentives for a given nation or bank to use a SWIFT alternative? If the best network is the one with the most members, why use anything else?
To answer this, first some quick context.
SWIFT isn’t alone
The presence of an entrenched leader doesn’t mean other nations have given up on building competing networks. Though SWIFT is, on paper, an internationally-controlled cooperative, it still has to be domiciled somewhere — in this case, Belgium. This means SWIFT is subject to Belgian law, which itself remains subject to EU-wide law, which through political and economic integration is influenced by American policy directives.
Through this lens, it’s not surprising that the two nations investing most heavily in SWIFT alternatives are those least inclined to freely comply with Western (read: American) financial influence: China with their CIPS network, and Russia’s SPFS. Quick note: there are more alternatives than just these two — India has created homegrown solutions, and even the EU briefly got in on the fun with INSTEX. We’ll focus mostly on China and Russia.
As the dollar’s dominance in international trade (almost 50% of SWIFT transactions) is increasingly used as leverage against adversaries, and as the US and EU take a growing liking to financial sanctions as a foreign policy tool, the value of a non-US dominated payment solution becomes clear.
Right now, China’s CIPS (Cross-Border Interbank Payment System) is the largest challenger to SWIFT, though it handles just a small fraction of transactions comparatively. (Technically, much of the CIPS network is built on SWIFT, but that’s a whole different article). It claims to have around 1,300 participants total, with over half of those based in China, the rest spread over 100+ countries. Along with offering new efficiencies for Asian markets, China is looking at CIPS as a way of serving their long-term goal of challenging the dollar as the world’s trade and reserve currency, by internationalizing their Renminbi. Alongside CIPS comes Russia’s SPFS (System for Transfer of Financial Messages), though it’s an even smaller player, with its roughly 400 members largely constrained to Russia and China.
For institutions that have long used SWIFT as their messaging platform, the switching costs to begin using a competing platform are high. SWIFT’s default position over the years has generated massive operational knowledge in the industry. When your bank is hiring for operations managers, AML teams, or banking tech roles, it’s almost certain any potential candidates have years of experience with the SWIFT protocol, and relatively little with anything else. Using a competing network alongside your SWIFT operations requires new training for internal teams, and opens up a new world of compliance and regulatory risk across international jurisdictions.
With this in mind, let’s get back to the initial question, what incentives drive adoption of these other networks?
Benefits of alternatives
Let’s cover the most obvious answer first: alternative solutions offer a way to avoid US/EU sanctions.
SWIFT is technically a neutral entity, but as mentioned above, that neutrality is limited by regional laws. Some examples are the case of Iran in 2012 — to comply with EU instructions, SWIFT disconnected all Iranian financial institutions from the network. A more recent example: the disconnecting of a handful of Russian banks from the network, again under pressure from the EU. If you’re particularly interested in buying Iranian oil, for example, the benefits of SWIFT alternatives are clear.
Of course, only in very rare cases has SWIFT been ordered to cut off sanctioned states from the network entirely. Plenty of nations live under Western sanctions (financial or otherwise) day-to-day and are still able to transact over SWIFT — it just usually means having to use the currency of a country that is happy to look the other way, or actively doesn’t adhere to Western sanction lists.
Still, in most cases, just not using the dollar or Euro isn’t a realistic solution, as the US and EU would still object to your transacting with the sanctioned country, threatening your friendly relations together. In this case, the privacy from Western eyes that a non-SWIFT solution offers is an attractive proposition.
With the obvious answer out of the way, let’s look at the more technical and pragmatic reasons a trade partner might lean toward a different network.
Fees are a big factor in the decision. Imagine this (very simplified) scenario:
You’re a small Brazilian bank and a client of yours needs to pay their Chinese supplier for a recent shipment of goods.
Your client, being a Brazilian business, ideally wants to pay with their Brazilian Real, but their Chinese supplier doesn’t import anything from Brazil, so that Real doesn’t do them much good. They want to be paid in Renminbi.
Being that you’re a pretty small institution, and you don’t often have to send any meaningful amount of money to China, you don’t bother keeping large reserves of Renminbi on hand, and you don’t have an account at a Chinese bank for the same reason. This means you have to find someone that does, and get them to pay the Chinese supplier.
This isn’t always easy — it means you’re looking for someone that wants to take your Real and also happens to have plenty of Renminbi on hand.
Being a small bank, your list of large institutional contacts who are likely to have deep accounts in both currencies isn’t too long. Instead, you’ll have to find multiple partners who can each handle a different step of the transaction.
You’re friendly with a US-based bank that happens to have good relations with a fair few Brazilian companies. They’ll happily take your Real, but they don’t have Renminbi on hand. So what they propose is to take your Real, and send the equivalent amount in dollars to a different American bank, which has deep pockets in both US dollars and Renminbi. That American bank will take those dollars, and send the equivalent Renminbi amount to the Chinese bank account of your client’s Chinese supplier.
Your client is happy: they’ve paid their bill in Real; their Chinese supplier is happy: they’ve been paid in Renminbi, and the two American middlemen are particularly happy — they just changed some numbers on their books and pocketed a fee for it.
This method works. It’s time-tested but expensive. And it’s exactly the sort of process that China is looking to replace with CIPS. To quote Chaoyang Zhang, an executive at Bank of China: “Opening an account in CIPS is somewhat equivalent to opening an account in China’s central bank.”
It would allow you, the small Brazilian bank, to have direct access to Renminbi reserves in China, without having to jump through the regulatory hurdles involved in opening the required accounts to hold RMB, or opening a dedicated bank account in China. Most importantly, it allows you to avoid paying fees to both those American banks along the way. This means lower fees for your clients and a better reputation among Brazilian businesses looking to trade with China.
Those American banks, known as Correspondent Banks, on top of taking their fee, also take their time in processing your transaction.
In an international transfer with SWIFT, each member in the chain has to verify the transaction’s validity and legality to be compliant with their jurisdiction’s KYC/KYB (Know Your Customer/Know Your Business) rules and local anti-money laundering compliance regulations. Though SWIFT itself doesn’t move the money, when they get the order via the network, they have to carry out the required checks before accepting the payment and continuing the next step of the transaction laid out in the message.
In the previous example, crossing through various third parties, these added checks can add multiple days to the total transaction time, which both the sender and (especially) receiver would rather do without.
On top of the added time and money taken in using correspondent banks, each additional link in the chain adds extra complexity to the transaction, particularly in the case of error. When something goes wrong, it’s much harder to identify who to contact and what to do when you don’t know “where” that wire transfer is (and each bank along the chain isn’t in a rush to take the blame).
For our small Brazilian bank, a direct contact in China via CIPS would save a whole lot of headache when things go wrong.
And things do go wrong. Day-to-day, most of the difficulty of working with correspondent banks comes from transactions being made more complicated along the chain, creating opportunities for error. But there’s a different type of risk present in having to go through middlemen to carry out a transfer — one that doesn’t appear as much of an issue until it very suddenly does: counterparty & liquidity risk.
In those rare, black-swan events, liquidity runs on correspondent banks are an issue that direct network integration largely mitigates. When your partner banks’ currency reserves suddenly deplete and borrowing costs skyrocket (almost overnight, in Russia’s recent case), quasi-direct access to that given currency’s central emitting bank is suddenly a much-appreciated perk.
SWIFT and CIPS are still only messaging networks, but the difference comes from CIPS being integrated more deeply into China’s financial system. In CIPS, the disconnect between the message and the transaction isn’t as pronounced — both are ultimately under the control of the same entity.
To return to that quote from the exec at the Bank of China, having a “[somewhat equivalent] account in China’s central bank” can help ensure stable operation of cross-border payments, compared to what would otherwise have been a multi-step, multi-nation transaction over the SWIFT network. (Though I’ll note that of CIPS’ 1300+ participants, less than 80 are “direct” members with accounts at the PBOC — all other members route their transactions through these direct members. While this does begin to resemble a correspondent banking structure, the difference is that most of these indirect members are in China already, and hold large RMB reserves, so the counterparty risk isn’t comparable.)
Local networks are local-friendly
I’ll wrap up with a final, and perhaps most significant, reason for which entities might choose to use a non-SWIFT messaging network: local networks are local-friendly. Let’s keep using the case of CIPS to illustrate.
This doesn’t apply in all cases but is largely applicable in the case of Russia and its close trade partners, and China and its neighbors: countries in close proximity to each other are more likely to have larger trade volumes between them.
This means there’s a good chance they hold more of each other’s currencies in reserves, making correspondent banks and central clearing authorities mostly redundant in carrying out trade and payments. They have aligned incentives to use common, local, payment rails. Through this lens, China’s geographically-closest trade partners should understandably be those who stand to most benefit from circumventing the SWIFT system. They already hold each other’s currencies, and mostly route payments directly through nearby Asian financial institutions, so why not opt for the benefits of deeper technical integration?
There’s an added efficiency here, too. In our very-online corner of the internet, it’s easy to forget just how important a role these messaging networks play in the context of physical trade.
Imagine you run a rubber-exporting company in Thailand, namely to your biggest rubber trading partner, China.
That rubber is crossing a not-digital ocean on a not-digital ship. If something goes wrong with payment, both parties would much rather be dealing with someone in the same timezone who can help solve the issue quickly. When things go very wrong, they don’t want to be hunting for a Brussels-based lawyer to bring SWIFT into the mix. Time zones, language, and local understandings still matter very much for real-world trade.
SWIFT (and by association, US & EU) dominance isn’t being replaced anytime soon, but there are clear reasons to use these first non-US-dominated alternatives if you’re a close trading partner with the country offering a tailor-made system.
CIPS, for the right customers, offers cost reduction, increased efficiency, privacy from the domineering US banking system and dollar supremacy, all while lowering risk for the average business, bank, or nation conducting the bulk of their operations in the same region as their customers.
Russia’s system cannot be expected to see breakout success anytime soon, and I’d argue the recent financial sanctions imposed on the country’s top banks have done far more harm to the SPFS project than they have good, but China is making strong steps toward creating a real SWIFT challenger.
The US has enjoyed its power over the global financial network for decades thanks to the dollar’s supremacy granting leverage over SWIFT. Its omnipresence supported by accrued industry knowledge and high switching costs will keep SWIFT cemented as the leading player in the near future on the global stage, if only by reticence toward being a first-mover in questioning the West’s go-to system.
But with each new financial sanction the West imposes on adversarial nations and banks, the rationale grows for at least exploring options to ensure future resilience by integrating fallback networks.
It’s not going anywhere quite yet, but starting with intra-regional trade, it’s beginning to look like the days of SWIFT being the only realistic option are behind us.