Can Russia's payment alliance with China get around banking sanctions?

Russia is working with China to run an end around Western payments systems, a move that will likely require more than just transaction technology to substantially ease economic stress on Russian banks. 

VTB, a Russian state-controlled bank with about $280 billion of assets, this week began supporting transfers to China in yuan, bypassing the SWIFT international payments messaging system, which banned Russia following its invasion of Ukraine in February. While the proliferation of payments technology over the past few years provides a plausible way for Russia to execute transactions without access to Western payment systems, it's a lack of access to Western capital that's the greater threat.   

"Pretty much any official government agency can set up a payments platform in collaboration with another government agency in some other jurisdiction," said Robert Hockett, a law professor at Cornell University. 

SWIFT is designed to ease payment flows between nations, and the organization has added technology over the past several years to support faster settlement to accommodate the growth of e-commerce. But since SWIFT is not a financial institution, access to SWIFT's members is more important for banks that are seeking credit from other banks. 

"What SWIFT provides is access to the global dollar-based payments system, which of course likewise entails access to the global dollar-denominated credit system," Hockett said, adding what VTB has announced does not provide that access. "And it is that access to credit which removal from SWIFT has taken away from Russian entities."

VTB, Sberbank and most large Russian banks are on the U.S. sanctions list, part of a series of moves against Russia that includes bans from Visa, Mastercard and most large U.S. and European payment companies, as well as hundreds of Western companies outside of finance. For Western companies, the costs so far have included compliance and security, while the war has contributed to higher energy costs in Europe and the U.S. 

Russia's gross domestic product is expected to decline about 10% in 2022, according to the BBC. Inflation is about 17%, and Russian businesses and consumers are increasingly seeking to do business in Chinese yuan as a hedge against the volatile ruble, with Russian purchases of yuan jumping 800% in 2022, according to Reuters. 

Russia has also courted UnionPay, China's national card network, to offset the loss of Visa and Mastercard, which controlled about 75% of Russia's card market before the war. Russia's Mir payment network, set up in response to earlier Western sanctions following Russia's incursion into Crimea in 2014, controlled about a quarter of the Russian card market before the Ukraine invasion. 

"VTB isn't going to be able to nest transactions through China in any volume to replace what they've lost access to," said Brian O'Toole, a nonpartisan senior fellow at the Atlantic Council, a nonpartisan research organization "Russia of course is turning to China, perhaps with less success than they claim," O'Toole said. "But it's not like there's some massive shift in U.S. dollar usage cross-border because of that shift."

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Russia has an existing equivalent system to SWIFT, called the System for Transfer of Financial Messages. Before the war, STFM handled about 20% of the messaging for Russian payments, though its reach and scale are limited compared with SWIFT's. For the past several years, Russia has attempted to recruit countries such as China, India, Iran and Turkey to STFM, though its level of success is limited.  

"STFM can process all local transactions, but few non-Russian banks are signed up to use it," said Elina Ribakova, deputy chief economist at the Institute of International Finance. "Theoretically, if there is concern that transacting with sanctioned Russian banks in euros or dollars might be equivalent to violating Western sanctions, an alternative could be using the Russian messaging system and transacting in other currencies." 

China has implemented a central bank digital currency, launching an e-wallet app that allows consumers to spend a digital yuan, placing China years ahead of the U.S. and most European nations in developing CBDCs. 

China developed its CBDC partly to counter the influence of the U.S. dollar, and it could work with Russia, which is piloting its own CBDC. "A next step could be to link those systems directly," Ribakova said. "That would remove the need for any additional messaging or payments and settlement systems and would be instantaneous." 

Beyond geopolitics, distributed-ledger technology firms such as Ripple have built digital payment messaging systems to rival SWIFT. The underlying blockchain technology could provide some traction for Russia as it attempts to build payment networks outside of U.S. and European influence. 

"New payment technology has made it easier for groupings of like-minded countries to establish their own payment systems," Hockett said, adding these networks can facilitate trade and credit flows among those countries. "But again, because it is the dollar system that gives SWIFT its principal clout, no such development is going to work any miracles for any countries looking to get out from under Western financial sanctions."