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Steve Hoy

SWIFT is Not a Payments System

I have often heard people who should know better talk about 'sending a SWIFT payment'. Later, when I moved into FinTech I was not surprised that many people did not know the difference between sending messages and moving money, so here's a quick & dirty explainer.

Actually transferring money is different from sending messages, and SWIFT is a messaging system (it's in the name, after all1).

Moving Money

From the Bank's perspective, all payments fall into three broad categories; on-us, domestic and cross-border.

  • On-us payments are where the payer and the beneficiary bank at the same Bank. All the Bank has to do to effect the payment is make the relevant accounting entries in their core-banking system, debiting the payer and (ultimately) crediting the beneficiary. There might also be some transaction reporting or other requirements, but that's pretty much it, no need to send payment instructions. Importantly, the Bank's liquidity position is unchanged and money does not move through the payments system.
  • Domestic payments are when the payer and the beneficiary accounts are with different Banks domiciled in the same country. In this case, the Bank debits the payer's account and then moves the money to the beneficiary's Bank via the Central Bank. The receiving Bank debits the due-from-banks account in its books and credits the beneficiary's account. Money actually moves off the balance sheet of the sending Bank and onto the balance sheet of the receiving Bank, meaning the sending Bank now has less liquidity and the receiving Bank more.
  • Cross-Border payments are when the payer and beneficiary accounts are domiciled in different countries. Here the Bank needs a correspondent banking relationship with another bank which is based in the beneficiary's country. Correspondent banking is one of the oldest arrangements in the Banking World and is complicated. Simply put, the money moves from the payer's Bank to the beneficiary's correspondent bank in the same country, while a parallel transaction occurs in the beneficiary's country, both sets of transactions using the respective domestic payments systems. Which Bank gets to do the FX is another matter 2.

As a heuristic, think that currency never really leaves the sovereign state that issued it (excluding dodgy bags of cash carried through airports, which is mostly illegal).

Sending Messages

When a Bank is presented with an amount of money by the payments system, it has to know what to do with it. If it doesn't know, it should DK 3 the payment and return the money to the sender, via the payments system. The receiving Bank gets to know what to do with the money because the sending Bank has sent it a message telling it to expect the amount and who the intended beneficiary is.

This is what SWIFT does - it moves messages between Banks. The actual movement of money – settlement – is done by the domestic payments systems involved (Faster Payments or CHAPS in the UK, TARGET in the eurozone, those sorts of things; every currency has at least one).

In the Olden Days Banks used Telex to send messages to each other; the Tested Telex. After striking a Correspondent Banking Agreement, the two banks would agree a 'test key' to authenticate their messages. Typically, this would add all the numerals contained in a message (such as amount, and value date), apply some form of salt (possibly just a sequence number and a 'secret' number), and add the resulting string to the message. The receiving bank would first verify the test key against the message before passing it to the relevant department for (manual) processing.

Telex is slow (c50 baud) and the messages are free-format over an insecure connection. Messages had to be managed by hand. So, in 1973 SWIFT was founded as a bank-owned cooperative in Belgium. Its job is to move messages between banks in a secure, fast and reliable manner, using known standards and is now so dominant that in order to be a Bank you pretty much need a BIC (Bank Identifier Code, issued by SWIFT).

SWIFT handles messages of many types, more than just payment instructions. Confirmations, statements, and free-format messages are all catered for; covering payments, foreign exchange, securities, trade documentary credits, metals - practically any Banking activity.

So SWIFT handles the transmission and exchange of payment instructions, while settlement of the payment is done using the payments systems of the countries concerned. SWIFT is not a payments system.

Down the rabbit hole

When I was learning about this stuff, a long time ago, I wondered how foreign-to-each-other Banks managed their liabilities. This led me to the Bank for International Settlements (BIS) and their strange currency, SDRs. Going deeper, you get to Purchasing Power Parity and tectonic shifts in fundamental exchange rates before finally confronting the Abyss and realising that it's all made up, money isn't real, and all is illusion.

1 SWIFT is an acronym for Society for Worldwide Interbank Financial Telecommunication.

2 If the beneficiary is receiving an amount of domestic currency (that is, no FX conversion, just one currency), then the receiving Bank just has some book entries to do.

3 DK means "Don't Know". DKs should include a message sent to the sending Bank stating that an amount has been received but the receiving Bank cannot apply the money to a beneficiary's account.