Can national payment systems protect economies against the risk of heavy third-party dependency?

Kledjona MollajConsultant at Shape the futurediscusses the latest changes to Russia’s internal payment system and the challenges the government faced during the invasion of Ukraine.

Disclaimer: Since February 2022, the Russian invasion of Ukraine has received very wide coverage. The following article attempts to explore the link between payment systems and geopolitical decisions and does not seek to comment on other aspects of the conflict.t.

Can a domestic payment system protect a local economy against international financial sanctions? Russia has demonstrated that it can, at least partially.

The Russian government has been actively taking steps since 2015 to ensure that its payment system can continue to operate even in the face of severe economic sanctions. The development of domestic payment alternatives could become more common among countries concerned about possible sanctions. The recent example of Russia highlights the geopolitical importance of payment systems. It remains to be seen whether Russia will become the proof of concept some countries need to develop domestic payment alternatives that can protect their economies.

But what did Russia do – and how well prepared was its payments system when the sanctions came into effect? Domestic card systems (DCS) have been used for many years to compete with international networks.

A card network is a payment system made up of two main elements:

  1. the element of the card scheme which defines the rules of the network, the pricing and manages the brand and the members of the scheme;

  2. the card processing element which covers the authorization, clearing and settlement of card transactions.

International Card Schemes (ICS) provide the infrastructure for issuing banks to issue cards – and for acquiring banks to acquire card transactions domestically or internationally. The biggest ICS are Visa and Mastercard.

A DCS, on the other hand, is an intra-country payment network that allows cardholders to transact only within that local jurisdiction. The efficient cost structure and ability to develop payment products specific to local market requirements makes DCS very competitive against international card networks on a national basis. 26 EMEA countries have already developed their own DCS for various strategic and economic reasons (eg Mir in Russia, Girocard in Germany, Multibanco in Portugal).

Russia – creation of its own DCS

In 2014, the Bank of Russia created the National Payment Card System, known as NSPK. Mir, a DCS, and the Faster Payments System (FPS), an alternative to SWIFT, were later created as subdivisions of NSPK. The aim was to reduce the risk of sanctions incurred when Visa and Mastercard had to withdraw their services from two Russian banks after the annexation of Crimea by Russia.

When developing a DCS, local stakeholders may choose to partner with an international network to lease its technology infrastructure (e.g. TROY – the Turkish DCS – has a partnership with Discover, the US-based ICS ) or develop a proprietary infrastructure. Mir chose the latter path.

Many DCSs also partner with international DCSs to ensure mutual acceptance through co-badging agreements and widespread use of cards in all markets. Mir partnered with UnionPay International, China’s ICS, to ensure co-branded cards would be accepted wherever UnionPay International was accepted, ensuring no reliance on US-based networks.

The Central Bank of Russia has also developed a national financial communication platform, the Financial Message Transfer System (SPFS). SPFS was an alternative to SWIFT to prepare the country for any future bans on its largest financial institutions from international transactions. Further evidence of this readiness can be seen in Russia’s decision to handle its payments abroad through the SPFS in non-Western currencies and its Central Bank’s goal to increase the SPFS utilization rate by 30% in 2023.

All of these actions were part of Moscow’s overall efforts to develop local financial tools to mirror those of the West, protecting the country in case sanctions against Moscow were expanded.

The impact on the Russian payment ecosystem amid the war on Ukraine

Unprecedented Western sanctions have been imposed on Russia so far this year and have effectively cut it off from the global financial system. Through its national payment schemes, the country has managed to mitigate some of the significant impacts anticipated.

After Russia invaded Ukraine on February 24, 2022, the ICS intervened. Visa and Mastercard blocked Russian financial institutions from their networks in response to government sanctions against Russian entities. On March 6, 2022, American Express (AmEx) announced that it was also suspending all operations in Russia and Belarus. Mir-branded cards, however, continued to work for domestic transactions, including co-branded Visa and Mastercard. Cardholders could still access their funds, make withdrawals and domestic transfers – at least until those bank cards expired.

Recent ICS actions should accelerate the adoption of Mir cards. According to Mir statistics, more than half of Russians already had a Mir card in September 2021, which represents 32% of intra-country transaction volume.

Mir cards are also accepted in other countries, including Turkey, Vietnam, Armenia, Belarus, Kazakhstan, and Kyrgyzstan. The central bank announced that many Russian banks now plan to issue cards co-badged with UnionPay International, which will be accepted in 180 countries, under mutual acceptance agreements starting in 2017.

In addition, Russia has also been affected by sanctions imposed to affect alternative payment methods (APM) like digital wallets and cryptocurrencies. Earlier in 2022, PayPal stopped accepting new customers in Russia and suspended its services there.

Apple and Alphabet (Google) have also severed ties between their digital wallet services and Mir. The EU has decided to ban the supply of high-value cryptocurrency services to Russia as well. The APM measures were an effort to put pressure on the country’s payment networks, since the effect on card transactions was significantly reduced. However, not all tech companies have followed the same path, with Samsung Pay continuing its operations in Russia.

Although Russia has been able to mitigate the impact of the imposed sanctions, its plan to replace international cards with Mir-branded cards has recently been called into question. The production of Mir cards stopped, because the chips for them were produced in Europe or Asia. Asian deliveries have also ceased due to the COVID-19 pandemic, while European deliveries are prohibited due to sanctions. The chip shortage is a significant obstacle to Russia’s plans to manage the strain on payment systems through in-house solutions.

National payment alternatives as a tool to protect countries’ interests in the future

The development of national payment systems has primarily focused on alleviating the commercial pressure of a minimally fragmented card payment market. However, as events in Russia over the past decade have shown, they can be an effective tool in reducing the vulnerability and exposure of a country’s payment systems to the international community.

Other SWIFT-specific alternatives, such as Russia’s SPFS, have already gained traction among countries concerned about possible future sanctions and suspensions. For example, China has developed CIPS, a new interbank payment system that could represent an alternative to SWIFT. Iran (which was banned from SWIFT in 2018) and Russia are also coordinating their efforts to combine the SPFS system with Iran’s financial telecommunications system, SEPAM.

National card networks and payment messaging systems have been shown to reduce dependence on third parties and therefore increase the independence of the internal market. The collective efforts of third countries to increase the impact of the sanctions imposed on Russia – and the resulting concerns about its ability to use domestic payment alternatives as a shield – support this assertion. We expect to see a growing number of countries worrying about potential penalties for adopting similar domestic payment tools.

Finally, in the event of a truce between Russia and Ukraine, it would be interesting to observe the Russian government’s response once the sanctions are lifted – and whether Visa, Mastercard and AmEx would resume operations in the country. Also, would Mir continue to work closely with UnionPay International in an effort to reduce ties with the big ICS?

About Kledjona Mollaj

Kledjona is an aspiring and highly motivated financial consultant. Since graduating from Alliance Manchester Business School with a Masters in Finance, she has worked as a consultant in a variety of industries including IT banking, retail and fintech, and has specific experience as a strategic advisor and in mergers and acquisitions.

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