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Primer on RU: Understanding SWIFT, Sanctions, and Correspondent Banking.

Luke Raven provides an accessible and clearly set out explanation of the issues surrounding the imposition and effect of financial sanctions.

What is Correspondent Banking?

The best way that I can help you visualise correspondent banking is by starting with a beach ball, being passed along by a crowd, who are performing a Mexican Wave. Let's do this.

The person who brought the ball can be the customer that walked into a branch, or opened their banking app, with the intent to send money across the world. Once they throw that ball, they've initiated a transaction bound for an account in another country. The ball is of course the money, and each person that touches the ball is a bank. When someone grabs the ball out of the air, that's a bank receiving money into an account that they specifically opened on behalf of another financial institution, the person who threw the ball. Thus, the movement of the ball from person to person is actually a movement of funds between the banks!

For a bit less of an ambiguous idea of how this works at scale, banks onboard one another and open accounts in different currencies for one another, which they will then accept instructions for dispersing. Anybody interested in the mechanics of this should look up "nostro/vostro accounts", which are what the banks refer to these accounts as, but I won't go into that here because it's both complex and extraneous to the point. Basically though, this system works really well if Customer 1 wants to send money to Customer 2, and Customer 1's bank knows Customer 2's bank (ie - those banks correspond). But due to a number of risk, regulatory and sheer cost factors, not every bank knows every other bank in the world, so sometimes things get a bit messy. Sometimes, the money needs to flow through a number of banks in order to finally end up in the correct account.

Now, while the money itself flowing in this way is useful to visualise, the Mexican Wave scenario doesn't explain the full system without further expanding. The first reason is that, while pushing a ball further in a crowd has almost no consequence, banks sending and receiving money can face severe repercussions. They can be heavily penalised for passing funds to the wrong person/bank, so they would not throw the ball to someone they don't know and trust. In fact, if they receive funds that they reasonably suspect are related to Sanctions, they can end up with regulatory reporting and disclosure obligations as well as a freezing requirement, so they don't even catch the ball from someone they don't know and trust. The beach ball has now transformed into a bag of cash that also may or may not contain Schrodinger's billion dollar fine - a package you don't go near unless you're sure the person before you has taken due care. If you want to read more about this concept, you should have a look at articles and laws relating to correspondent banking due diligence.

There's two other reasons that we must really transform the ball into a bag of cash to keep the visualisation alive, and they're both very practical ones. The first is that banks need an incentive to be involved in the transaction at all, and a beach ball isn't something they can take a cut of. With international funds transfers, each bank along the transaction path charges a fee, both for the compliance checks they need to conduct, the account, and the connections (other banks with whom the sender doesn't have a relationship) that they bring to the table.

Lastly, of course, the intent of the sender of a transaction isn't to have fun and surrender their "ball" (money) to the moment - it's to get the funds involved to a specific party for a specific purpose. With no intelligent design there's no conceivable way that the money (beachball) will get where it was initially intended to go... because SWIFT hasn't yet come into play.

What is SWIFT?

First and foremost, SWIFT is quite possibly the best acronym in existence. It stands for the Society for Worldwide Interbank Financial Telecommunications, which has stuck with me ever since my first day working in Sanctions when it struck me as a stroke of pure genius. As with all aptly named things, the clue to what it does is in the (expanded) name - it is a messaging system between banks. There's a lot of explanations right now about SWIFT being plumbing or gas or a thermostat or an irrigation system. These are very nice, but ultimately not needed when SWIFT is just a messaging system for banks, which is already extremely understandable in the day and age of email and IM, which is essentially all it is on a closed and secure platform.

What flows through SWIFT are various message types - literally classified as "MT" before a number, which will then correspond to a certain meaning for the message. Common ones for Sanctions analysts to run across are 'payment for value' MT103's, which will include information about sender, beneficiary, payment purpose, and banks involved, but there are legion other more complex types which I won't go into here. Essentially though, if banks need to communicate in order to help pass the beach ball / bag of money between accounts, and to ask whether or not it might contain a grenade, there will be a corresponding message or messages sent via SWIFT. For that reason, SWIFT commonly rings with what might be considered the modern day, corporate equivalent of the early day internet chat room mainstay, "ASL?" Of course, instead of attempted romance, the institutions on SWIFT are more interested in the Age, Sex and Location of the people involved in the transfer.

One thing that's often missed is that it is absolutely possible to send money without SWIFT, and in fact, absolutely impossible to send money with only SWIFT, since SWIFT is only the 'email' or messaging between various correspondent banks. It is also worth noting that, while you can send funds (and instructions relating to those funds) without SWIFT, doing so is painful, difficult, and you may not have the correspondent bank options further downstream that you wish you did. If SWIFT is a text message between people trying to catch the "ball", instructing them where and how to send it, then developing an alternative might be like setting up a carrier pigeon network.

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