Understanding the SWIFT payment system

What is SWIFT?

The Society for Worldwide Interbank Financial Telecommunications (SWIFT) is a global messaging network used by banks to send and receive information, such as money transfer instructions.

In the simplest terms, this allows payments to be sent and received between payers who use different banks than their respective payees.

Who uses SWIFT?

The SWIFT network has grown significantly over time, and it is currently utilized by a diverse range of institutions including:

• Banks
• Securities dealers
• Clearing houses
• Exchanges
• Brokerage institutions 
• Foreign exchange institutions
  

Who owns the SWIFT system?

SWIFT operates as a cooperative owned by its shareholders, which comprise specific member financial institutions representing numerous firms globally. 

Oversight of SWIFT is managed by the central banks of the Group of Ten (G-10) countries. These countries include Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States. Belgium, within Europe, takes the lead in overseeing SWIFT, alongside other members such as the U.S. Federal Reserve.

Given that all countries depend on SWIFT for efficient, secure communication, there is a shared interest in maintaining a positive relationship with the organization. While central banks from G-10 countries supervise SWIFT, it remains a neutral entity operating for the collective benefit of all its members.

Since launching in 1977, the SWIFT banking system has served as the backbone for international money and security transfers, facilitating communication among over 11,000 global financial institutions. Despite its pivotal role in global finance, SWIFT itself is not a financial institution and does not handle asset transfers. Instead, it provides a platform for member institutions to communicate and conduct transactions seamlessly. 

This platform operates as a vast messaging network, enabling institutions to transmit information, including money transfer instructions, using standardized codes known as bank identifier codes (BICs) and SWIFT codes. 

How SWIFT Transactions work

From the point of view of the sender, making an international money transfer using the SWIFT network is fairly straightforward. The sender’s bank sends a payment transfer message through the SWIFT network, using information including the SWIFT code of the recipient’s bank.

Understanding SWIFT Codes

SWIFT codes serve as unique identifiers issued and overseen by SWIFT to participating financial institutions. These codes play a crucial role in guiding payments to the correct bank, regardless of its location around the globe. To obtain a SWIFT code, banks must become members of the SWIFT network.

BIC or SWIFT? These terms are used interchangeably, along with others such as SWIFT/BIC, SWIFT ID, or ISO 9362 code.

Each code is between 8-11 digits, structured from identifiers for institution name, country, location and branch.

‍

One Code to Rule Them All: In most countries worldwide, banks use the same SWIFT code for all incoming transfers. The code is provided by the sender – along with information like the account number – to ensure that payments are deposited in the intended account. In the US, on the other hand, banks often use different SWIFT codes for different payment types or branches.

Sending money with SWIFT

After the transfer is initiated at the originator bank, using the SWIFT code of the recipient bank, as well as information such as the recipient’s account number, the recipient’s bank receives the message, clears and credits the money to their bank account.

Example 1: Tina wants to send money from the US to her friend Lucia in Colombia. She goes to her local Citibank branch with Lucia’s Colombian bank account number and the SWIFT code for Bancolombia, COLOCOBM. Citibank sends a SWIFT message to Bancolombia – when Bancolombia receives the SWIFT message, it credits the money to Lucia’s account.

It is important to remember that no funds are sent via SWIFT. SWIFT’s purpose is to act as a network for banks to communicate payment information – it does not handle actual money.

The actual movement of funds occurs between Nostro and Vostro accounts of the originator and beneficiary banks – or, commonly, intermediary banks between the two.

Nostro and Vostro accounts

Banks that have commercial relationships open accounts at each other’s bank with funds to cover SWIFT payment requests.

Example #2 Citibank and Bancolombia have a commercial relationship. Citibank opens an account with Bancolombia and deposits funds to handle payment requests, and Bancolombia likewise opens an account with Citibank.

In these relationships, the account holding funds is called a “Nostro” account by the bank depositing money. That same account is called a “Vostro” account by the bank where the account is held. The banks have a matching ledger for each “Nostro/Vostro” account.

When a SWIFT transaction is initiated between banks with Nostro/Vostro accounts, money transfers are completed by simply moving funds from a “Nostro” account at a bank to the “Vostro” account, and then distributing the funds to the end recipient’s bank account.

No further transfers are required in this instance, because the funds to cover SWIFT payments are already held in the recipient’s bank. Only the message from the SWIFT network with payment instructions is necessary.

In the case of banks without commercial relationships, one (or more) intermediary banks is required to complete the transaction.

Correspondent Banks

When a money transfer is required between two banks that do not hold Nostro/Vostro accounts with each other, funds must be moved between correspondent banks in the SWIFT network that do have such a relationship.

Example #3 A money transfer is required between Bank A and Bank B, but those banks do not hold Nostro/Vostro accounts with each other. However, both have accounts with Bank C. Through the SWIFT network, the payment instructions require Bank C to move funds from their Vostro account to their Nostro with Bank A. Then, Bank B moves funds from their Vostro account to their Nostro account with Bank B, and then dispersers those funds to the end recipient – minus a fee charged by Bank C.

As the number of intermediaries required to complete a transaction grows, the fees accumulate, the settlement time takes longer, and the chance of errors increases.

How SWIFT makes money

SWIFT generates revenue through several channels:

1. Membership Fees: SWIFT members belong to different classes based on share ownership. All members pay a one-time joining fee along with annual support charges, which vary depending on the member class.

2. Additional Services: Business intelligence, reference data, and compliance services, provide SWIFT with additional income streams beyond its core messaging services.

3. Message Fees: SWIFT charges users for each message sent, based on the message type and length. These charges are determined by the bank's usage volume, with different charge tiers for banks generating varying message volumes.

SWIFT Fees

Due to the possibility of one or more intermediary banks adding fees as transactions move through the network, SWIFT fees can be high and unpredictable. Often, a sender doesn’t know exactly how much they will be paying when they initiate a transfer.

Typical fees associated with SWIFT transfers include:

1. Outgoing transfer fee: Charged by the sender's bank for initiating the SWIFT payment.

2. Incoming payment fee: Levied by the recipient's bank, and potential intermediary banks, for processing incoming SWIFT transfers.

3. Foreign exchange fee: Applied when converting payments into different currencies, this fee depends on the exchange rate and the bank's policy.

4. SWIFT tracing fee: Optionally incurred for monitoring the progress of a transfer, particularly if there are delays or discrepancies.

Tracing SWIFT: MT103 documents are the standard “proof of payment” for SWIFT transactions. For a fee, senders can access the MT103 for their transaction to see information such as the processing institutions, the amount, fees and more. While this can inform senders of issues that may have arisen in their transaction, it cannot provide details on how they can or will be resolved.

Responsibility for paying SWIFT fees can vary:

• Sender pays all fees (coded as "OUR")
• Recipient pays all fees (coded as "BEN")
• Fees are split between sender and receiver (coded as "SHA")

How Secure is SWIFT?

While SWIFT is a widely trusted system for facilitating international transactions, it's not immune to vulnerabilities. Understanding these vulnerabilities is crucial for financial institutions and individuals involved in SWIFT payments to mitigate risks effectively.

1. Cybersecurity Risks: Cyberattacks targeting SWIFT infrastructure, such as malware infections and phishing attacks, pose significant threats. These attacks can lead to unauthorized access to sensitive financial information, fraudulent transactions, and reputational damage.

2. Fraudulent Activities: Human error or malicious intent can result in significant consequences. Fraudulent activities may involve unauthorized fund transfers, falsified payment instructions, or identity theft.

3. Insider Threats: Employees with privileged access to SWIFT systems may abuse their positions to engage in fraudulent activities or leak confidential information to external parties. These threats can be challenging to detect and prevent.

4. Compliance and Regulatory Risks: Failure to adhere to anti-money laundering (AML) and know-your-customer (KYC) regulations, as well as sanctions compliance, may result in penalties, fines, and reputational damage. 

5. Operational Risks: System outages, technical glitches, and processing errors, can disrupt SWIFT payment operations and cause financial losses. Dependence on interconnected systems and third-party service providers increases the complexity of managing operational risks. 

6. Geopolitical and Economic Factors: Disruptions to international banking relationships, changes in regulatory frameworks, or geopolitical conflicts may impact cross-border payment flows and increase uncertainty for financial institutions.

The future of SWIFT

Since its launch in the 70s, the SWIFT network has grown rapidly to become the de-facto method for global money transfers.

While the network itself, and its ability to send payment messages, is fairly fast and secure – the actual money movement involved has a lot of room for improvement. 

Cost

Banks typically impose a 2-5% charge to cover exchange rate costs during currency transfers, with additional charges often applied by individual banks. Moreover, there is a complex array of fees for possible intermediary banks, and recipients may also incur charges for receiving the funds.

Speed

Cross-border payments using the Swift network typically take between one and four working days. This delay is because international transfers on Swift can only occur during foreign exchange market hours. For example, if a payment is initiated late at night, it will need to wait until morning in its destination country to be processed. Furthermore, weekends and bank holidays further extend the processing time

Security

Vulnerabilities such as fraud, human error and cybersecurity risk can have an impact on the security of the network – resulting in possible financial loss.

What’s Next?

As we've explored these limitations, it prompts the question: Can we go beyond SWIFT for cross-border payments?

For more information on how Conduit is building a new way for businesses to send cross-border payments, contact us here.