Finance & economicsPipe dream
Russia looks to Chinese financial plumbing to keep money flowing
It isn’t connected to the world well enough to help much
NATIONALIST BLOGGERS in China have a new fascination: global payment systems. Vladimir Putin’s attack on Ukraine, followed by Western sanctions on Russia, have prompted internet pundits to extol the virtues of the Cross-Border Interbank Payment System (CIPS), the rails on which Chinese banks transfer and clear yuan-denominated payments around the world. Some have also taken to bashing SWIFT, the Belgium-based financial messaging system that has started excluding Russian banks from international payments. “That thing called SWIFT cannot be relied on,” avers one popular blogger on Weibo, a Twitter-like platform.
CIPS and SWIFT are far from being household names in China. But the sweeping sanctions against Russia—on the usage of SWIFT by some of its banks and on its central bank—have put a spotlight on China’s homegrown financial networks, and the extent to which it can use them to help Russia. Three primary Chinese financial channels are in place to assist—two legitimate, one not. None are remotely adequate substitutes for the links to the Western financial system that Russia has lost.
First, consider the direct connections between the two countries’ central banks, which do not require SWIFT messaging to transact. Russia has about $90bn-worth of mainly yuan-denominated deposits held with the Chinese central bank. It also has a 150bn-yuan swap-line agreement with China. It can use these funds to finance imports from China in the event that other trade-finance routes in dollars are blocked, note analysts at Natixis, an investment bank.
But this trade will largely remain in yuan, limiting what Russia can purchase. China’s regulators are still keen to avoid American “secondary” sanctions. Primary sanctions target Russian institutions and American firms that deal with them. The secondary sort have yet to be used, but would target third parties outside America that transact with Russian firms, even if those transactions are permitted by local law. Allowing Russia to sell yuan-denominated assets in order to raise dollars could attract scrutiny and goes beyond what Chinese officials are willing to do for their friends in Moscow, reckons Rhodium, a consultancy.
Next, there are the several complex financial networks China has spent decades building around the globe. Take, for example, the web of state-owned banks that have cropped up in commercial hubs around the world. China’s banking regulator may have stated on March 2nd that the country would not join Western sanctions, but most of its big banks will adhere to them, particularly those that interact most with the Western financial system and have legal entities that are domiciled in America. The four largest Chinese state-owned banks, for example, all have branches in Moscow. But according to the Federal Reserve, those same four firms also have offices in America which collectively had $106bn of assets at the end of September.
These large institutions that conduct the bulk of trade finance between the two countries are highly unlikely to risk getting blocked from dollar clearing in order to continue doing dollar-denominated business with Russia. Two large state-owned banks stopped issuing dollar-denominated letters of credit for purchasing Russian commodities as soon as sanctions were issued, according to Bloomberg, a news service. Maintaining full access to global financial markets is “more valuable than anything Russia can offer”, according to Neil Shearing of Capital Economics, a consultancy.
UnionPay, China’s state-owned bank-card firm, is another powerful financial network. It is set to gain market share in Russia in the wake of the departures of Visa and Mastercard, the American-based giants of global card payments, which were announced on March 5th. Several Russian banks have said that they will move to UnionPay, which already has a significant presence in the country.
This shift will not come easily, however. Within Russia, UnionPay’s network is small and many banks do not have prior agreements with the company. Banks will need to show they meet network requirements to be licensed as a card issuer, says Zilvinas Bareisis of Celent, a research group. The cards must be designed, certified and then distributed—a process which can take months. For Russians abroad the problem is that, despite being in more than 180 countries, UnionPay is a fringe service in America and Europe, says Jason Ekberg of Oliver Wyman, another consultancy. UnionPay could also open itself to secondary sanctions by offering some types of services to sanctioned Russian banks.
CIPS, meanwhile, will not be the miracle solution Chinese bloggers hoped for. That is because China has not been able to roll out its own messaging system. Foreign banks linked to CIPS still use SWIFT messaging to operate, notes Edwin Lai of Hong Kong University of Science and Technology. That means Western sanctions will still apply to any transfers between SWIFT-barred Russian banks and foreign banks.
A final route for financial assistance will come through backchannel banks that dodge sanctions. China has a long history of turning a blind eye to smaller banks that finance trade with countries targeted by America and the UN. These activities usually occur on a small scale. And many are caught in the act and hit with secondary sanctions themselves. In 2012 Bank of Kunlun was hit with American sanctions for making $100m of payments with an Iranian bank. Five years later American regulators accused Bank of Dandong, another smallish lender, of dealings with North Korea. Some Chinese banks may take the risk with Russia, but these institutions will be minnows that are unable to provide the large-scale assistance Russia needs.
All told, Sino-Russian financial links appear weaker than Russia might hope. The situation is likely to raise questions about the shortcomings in China’s efforts to build global financial networks. For CIPS, many of the problems are clear. In order to maintain control over capital flows, China has not linked the system directly with foreign banks outside mainland China, with the exception of Standard Chartered, a British bank with long-established links to China. CIPS’s indigenous messaging system works only with Chinese banks. To improve the system, China must continue opening it up and granting more direct links with foreign banks.
The lack of such links makes the system more difficult and less attractive to foreign financial institutions. CIPS is for the most part illiquid, says Natixis. It processes just 13,000 transactions per day, equivalent to about 5% of those processed by America’s domestic-payments system, known as CHIPS.
China’s President Xi Jinping has referred to Mr Putin as a “best friend”. The Russian conflict is laying bare some of China’s financial vulnerabilities. That may make the relationship less amicable.