Over the weekend (after much hesitation), the European Union sent a strong signal with a (partial) exclusion of Russia from the SWIFT system. This will quickly and considerably complicate any private sector financial transactions with Russia or limit them to a minimum. It will also make it more difficult for Russia’s central bank to stabilize the rouble in the short term.

Nevertheless, depending on how the situation develops, European policymakers, in unison with the USA and other partners, are forced to consider steps that go beyond a partial SWIFT exclusion as indicated by recent sanctions on the Russian Central Bank (CBR), i.e. recent reserve asset freezes. This step can, of course, be interpreted by Russia as “economic warfare” and therefore certainly harbours further risks of escalation/countersanctions. With the comprehensive CBR sanctions, Russia stands in a group of countries like Iran, Afghanistan, Myanmar.

Without SWIFT, the minimal economic exchange between Russia and the West that would still be necessary in the future could only be carried out with difficulty. Yet that is exactly what is needed if Moscow makes no “credible” change of policy and continues to pursue the current course of action in Ukraine. Before SWIFT was established in 1973, payment transactions were made globally and with the Soviet Union, but they were difficult.

Under the assumption that there is no massive course correction in Moscow, Europe no longer needs deep economic integration and rapid payment processing with Russia for the time being or even longer. At least payments for a lot of economic actors, mid-market companies and a lot of banks are needed. And SWIFT is made for that. Selected payments can be made via special infrastructures (like it partially happened with Iran).

Why “more than SWIFT” is possible and necessary

So far, the SWIFT exclusion has been presented by policymakers as a maximum variant or so-called “nuclear sanction.” However, given the policy of the current Russian rulers is aimed at maximum “gains” in the case of Ukraine, even more, far-reaching, globally effective financial sanctions of the western world and the EU may become necessary – if the EU is serious about asserting its sovereignty. Tougher economic sanctions are under consideration.

In this way, countries with (partial) sympathies for Russia can be prevented from offering a certain degree of protection or a backstop to Moscow.

Sanctioning the Russian central bank and the use of the euro – the real “nuclear option”

A direct and almost comprehensive sanctioning of the Central Bank of Russia (CBR), as well as a sanctioning of the use of the euro (as has already happened in part for individual Russian banks for the USD), could also be necessary.

After all, next to the USD with 40-45 percent, the euro with 16-20 percent accounts for the largest share of global foreign exchange market turnover. Other currencies that are also sanctionable are far behind (British pound GBP about 6-7 %, Japanese yen JPY 8-10 %.)

Sanctioning the Russian central bank in at least some areas like access to its foreign currency reserve assets and sanctioning the use of the euro is certainly a maximum option for “the West” and the EU. It would de facto impede any attempts of the CBR to undermine western sanctions and raise the threat of a systemic collapse in Russia.

Russia may not have expected the European Union to act here

This could be the only way to prevent foreign currency inflows to Russia or to make them punishable. This is relevant insofar as Russia has deliberately relied on the use of the euro in recent years while the Chinese yuan and the Hong Kong dollar currently account for a combined global share of just under 4 percent of global foreign exchange trade.

As for SWIFT, Russia has probably prepared itself in some way for a (partial) exclusion. The assumption to the contrary is irrational, given the fact that this policy instrument has been discussed for a long time and the SWIFT network has been actively criticised for years by Russia and China as a “western” system of domination.

The China factor – Why the global impact of sanctions is important

Firstly, sanctioning the Russian central bank and/or the use of the euro would clearly make it more difficult for China or other actors to undermine other western sanctions. After all, China – unlike Russia – massively depends on integration with the western financial system. China needs access: directly as a country itself and “indirectly” via the global financial centre of Hong Kong, both to be able to continue its own economic rise and the very cleverly orchestrated opening of its own capital market while at the same time using the financial centre of Hong Kong.

Let’s not forget that Russia’s banks have, of course, actively been trying to gain a foothold in the Hong Kong financial centre as a “secret hub” in recent years. To sketch relevant dimensions here, Russia’s interconnections with the global and western banking market are at 165 billion USD as compared with China’s about 2700 billion USD equivalent (directly and indirectly via Hong Kong). So from a Chinese perspective, a few billion USD of “Russia financing” could certainly be accommodated if this was legally still possible. Therefore, it is important that western sanctions have a truly global impact.

As sanctioning the Russian Central Bank and the use of the euro is definitely the financial “nuclear option,” a “phasing out” or “take back” option must be considered and communicated in parallel.

A broad sanctioning of the use of western currencies plus the Russian central bank (and important private commercial banks) by the USA, the EU, and the rest of the western world would force Russia into “barter trade” with their other remaining economic partners. Consequently, Russia’s economy would not stay afloat in the long term.

Bringing Russia close to a 1998 scenario

Secondly, the confidence of Russia’s population in macro-financial stability would be undermined. Currently, there are about 90-100 billion US dollars’ worth of bank deposits in Russia from private customers and more than 150 billion US dollars’ worth of corporate bank deposits. Uncertainty could increase here in the event of maximum sanctions, and so the reserve cushion of the Russian central bank could melt away even faster. Currently, Russia has 20-30 months of import cover through foreign exchange reserves (depending on the calculation method and assumptions.)

It might be necessary to shorten this period even further. Then system confidence would massively decrease. There would also be a risk of a bank run in Russia, and the Russian government would probably have to offer all depositors roubles – no longer the option of foreign currency – if the sanctions are in place for longer. In the short term, Russia may close local financial markets and banks tomorrow.

 “Phasing out” or “take back” options and compensation mechanisms to minimise risks

All rather “normal” economic and financial sanctions will probably have to remain in force for years (or decades) unless there is a change of policy and action in Russia.

However, the above-described maximum financial sanctions of “the West” should be phased-out or lifted to minimise the risks they entail if Russia indicates any readiness for talks or a ceasefire on terms that are acceptable to Ukraine. Also, Russia could close the local financial market for two days and, if there were credible talks, parts of Russia’s foreign exchange reserves could be released after a specific time and withholding period.

At present, Russia has capital market links with the west in the range of EUR 250 billion, which is higher than in 1998, at the time of the Russian crisis on the local and global financial markets (then just under 100 billion). The risks, which are probably lower than the risk exposures of the euro crisis, should be bearable, especially if central banks and regulators prepare now – which may happen right away.

At the same time, self-interest must be weighed in the sanctions policy. In this respect, slight deviations in the sanctions policy between the EU and the USA could be considered in some areas, and EUR/RUB financing should not be completely cut off – at least for now. Trade relations in Europe are on a completely different level than they are in the US. Payment defaults would reach far into the European mid-market company segment. However, this makes it all the more important to quickly provide compensation mechanisms.

Support functioning of the Ukrainian financial system

At the same time, Europe should support Ukraine as much as possible. In addition to a donor conference, the short-term goal will be to secure Ukraine’s central bank’s (NBU) liquidity position and have the European Central Bank (ECB) set up a foreign exchange swap line here. And this shall possibly not be tied to assets at the NBU but secured by the EU.

The provision of cash holdings (covered by Ukraine aid money) could also help in the short term. Confidence in the functioning of the Ukrainian state and central bank must be supported to the maximum. In contrast, the opposite might be indicated for Russia and its central bank in the coming days.

In the current era of the power of images and social media, it may be an interesting side note in times of human suffering that access to foreign exchange is more difficult in Russia than in Ukraine.

This view represents the personal and private opinion of the author Gunter Deuber and not necessarily the position of Raiffeisen Bank International AG.

Read more on the Russian economy from Gunter Deuber

Russia’s Defensive Economic Model: Paper Tiger Reforms and State-led Investment Spending as Patchwork Fixes

Read more from Miriam Kosmehl on the geo-political landscape of Russia’s invasion of Ukraine.

Europe’s divided security


Gunter Deuber is Managing Director and Chief Economist of Raiffeisen Bank International AG in Vienna. He collaborates closely with a team of local economists on-site in 14 countries in Central and Eastern Europe, for whom he has a steering and coordination function.