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We live in a technological age today and hence are afforded many conveniences which people in the prior generations did not have. For instance, today, if we want to transfer money to a person or an entity in a different part of the globe, it can be accomplished with a few clicks and within a few seconds.
This was not always the case. Earlier communication between banks was happening using the Telex system. This means that banks had to describe each transaction in words and then send them to a different bank. Then, the other bank would interpret these instructions and perform the necessary task. Needless to say that this entire process was lengthy, expensive, and prone to manual errors.
With the passage of time, international trade increased. Hence, cross border payments became more and more common. Over time, a need was felt to expedite cross border payments. This was when the SWIFT network came into existence. Today, SWIFT is one of the central pillars on which the global financial system stands. It is instrumental in completing millions of transactions that take place every day.
This article will explain what the SWIFT network is and also how it adds value to the global financial system.
Contrary to popular belief, the SWIFT network is not a payment network. This means that the network does not transmit cash or currency in any form. Instead, the network only transmits messages. Therefore, when one bank sends a SWIFT message to another bank, it is just instructing the bank to pay the beneficiary on their behalf. The actual exchange of hands takes place between banks separately. However, since customers get paid after a SWIFT message is sent, they often consume SWIFT messages with actual payments.
The first step towards understanding SWIFT is understanding that it is nothing more than a standardized messaging system. Therefore, the information which was sent in full-length sentences using Telex earlier can now be sent in codes electronically. For instance, each bank branch has a unique SWIFT code. Therefore, if a bank has to send money to a different branch, they need to specify the unique SWIFT code. Since each bank has a unique code, the chance of an error is practically reduced to zero!
Also, there are various types of standardized formats for every transaction. Payment orders have a predefined format, and so do bank statements. Therefore, the receiving bank can easily identify the instruction being sent just by reading the type of file which is being sent. Also, each of these formats has predefined nodes for information that might be required by another bank. Hence, if the file being sent has incomplete or incorrect information, it will be pointed out by the system.
SWIFT payments are faster and more convenient since all banks form the part of one single network. This means that if one bank wants to connect with a hundred other banks, they do not have to create a hundred different interfaces. Instead, they can create just one interface and transfer the payment details to SWIFT. SWIFT can then use the information in the file to locate the recipient bank and provide them with the necessary information.
Hence, since SWIFT is a network and all banks connect to it, information can be transmitted faster, cheaper, and without the need for building expensive interfaces.
SWIFT is actually a non-profit organization. The SWIFT was created as a co-operative society between several banks who were tired of using ineffective methods of sending payments. Its purpose is not to make money. This is because if SWIFT was a for-profit organization, it would add up to the transaction costs. These high transaction costs would make the concept of SWIFT unviable. The SWIFT network is widely used because apart from being convenient, it is also highly cost-effective.
However, it needs to be understood that SWIFT does charge money to its users to send messages. This charge is based on the type and the length of the message. Banks that generate a high volume of messages every day are given a discount and charged a lower rate per message. This is because once the infrastructure is set up, SWIFT does not have to spend additional money to spend more messages. Hence, they encourage banks to send more and more messages by giving them volume discounts.
SWIFT also provides certain add on services and automated solutions for a price. This helps create ancillary revenue streams for SWIFT without adding to transaction costs.
SWIFT based messaging is difficult to install at first. There is a significant upfront cost for banks to create systems that are compliant with SWIFT messages. The new software has to be developed, and new hardware needs to be purchased. However, once this upfront cost is incurred, there is very little subsequent cost involved.
Nowadays, banks are creating highly automated payment systems by leveraging the capabilities provided by SWIFT. This automation can also prove to be expensive. The bottom line is that the SWIFT network is more useful for banks that have large sums of money that they can afford to invest upfront.
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