London CNN Business  — 

The West has pledged to remove some Russian banks from SWIFT, a messaging service that connects financial institutions around the world, as part of a barrage of sanctions designed to limit Moscow’s ability to pay for its war in Ukraine.

The United States, the European Union, the United Kingdom and Canada said in a joint statement on Saturday that they would disconnect “selected” Russian banks from SWIFT in order to punish Russia for invading its neighbor.

“This will ensure that these banks are disconnected from the international financial system and harm their ability to operate globally,” said the Western powers.

What is SWIFT?

The Society for Worldwide Interbank Financial Telecommunication was founded in 1973 to replace the telex and is now used by over 11,000 financial institutions to send secure messages and payment orders.

SWIFT doesn’t move money around the world. What it does is allow banks to send each other instructions on how to transfer funds across borders. With no globally accepted alternative, it is essential plumbing for global finance.

Disconnecting an entire country from SWIFT is considered the nuclear option of economic sanctions.

But even limited action can have a big impact. Any bank disconnected from SWIFT will have a very difficult time sending money to other financial institutions, and its customers will struggle to conduct their business.

Why only ‘selected’ banks?

Removing every Russian bank from SWIFT would have a huge impact.

“The cutoff would terminate all international transactions, trigger currency volatility, and cause massive capital outflows,” Maria Shagina, a visiting fellow at the Finnish Institute of International Affairs, wrote in a paper last year for Carnegie Moscow Center.

Excluding Russia from SWIFT would cause its economy to shrink by 5%, former finance minister Alexei Kudrin estimated in 2014, the last time the sanction was considered in response to the Russian annexation of Crimea.

But such a dramatic move would also hurt the West.

The United States and Germany have the most to lose if Russia is entirely disconnected, because their banks use SWIFT most frequently to communicate with Russian banks, according to Shagina.

Senior Russian lawmakers have said that shipments of oil, gas and metals to Europe would stop if the communication channel is disrupted.

“If Russia is disconnected from SWIFT, then we will not receive [foreign] currency, but buyers, European countries in the first place, will not receive our goods — oil, gas, metals and other important components,” Nikolai Zhuravlev, vice speaker of Russia’s upper house of parliament, said recently, according to state media outlet TASS.

That helps explain why the West is moving to unplug only certain banks. How many banks are targeted — and which ones — will ultimately determine the economic impact of sanctions for both Russia and the countries it trades with.

Neil Shearing, chief economist at Capital Economics, said investors should watch to see whether Gazprombank is targeted since it handles a large share of Russia’s energy exports.

What does SWIFT say?

SWIFT is based in Belgium and governed by a board consisting of 25 people, including Eddie Astanin, chairman of the management board at Russia’s Central Counterparty Clearing Centre.

It describes itself as a “neutral utility,” is incorporated under Belgian law and must comply with EU regulations.

“We are engaging with European authorities to understand the details of the entities that will be subject to the new measures and we are preparing to comply upon legal instruction,” SWIFT said in a statement over the weekend.

Has this ever happened before?

There is precedent for removing a country from SWIFT.

SWIFT unplugged Iranian banks in 2012 after they were sanctioned by the European Union over the country’s nuclear program. Iran lost almost half of its oil export revenue and 30% of foreign trade following the disconnection, according to Shagina.

Are there any alternatives to SWIFT?

Russia has taken steps in recent years to blunt the trauma should sanctions include SWIFT.

Moscow established its own payment system, SPFS, after it was hit by Western sanctions in 2014 following its annexation of Crimea. SPFS now has around 400 users, according to Russia’s central bank. Twenty percent of domestic transfers are currently done through SPFS, according to Shagina, but the size of messages are limited and operations are limited to weekday hours.

China’s fledgling Cross-Border Interbank Payment System, or CIPS, may provide another alternative to SWIFT. Moscow could also be forced to resort to using cryptocurrencies.

But these are not appealing alternatives as neither system has a significant global presence.