SWIFT Wire Transfers: What Compliance Needs To Know
Disclaimer: The contents of this article are intended to provide a general understanding of the subject matter. However, this article is not intended to provide legal or other professional advice and should not be relied on as such.
The Society for Worldwide Interbank Financial Telecommunications, commonly known as SWIFT, provides a secure, standardized network environment that allows financial institutions worldwide to exchange information about financial transactions.
It’s critical for compliance professionals to understand the fundamentals of SWIFT wire transfers, in order to interpret payment message data, assess transactions for suspicious activity, and effectively screen for involvement with sanctioned parties.
SWIFT was founded in Brussels in May 1973, supported by 239 banks in 15 countries. Its initial objective was to establish common data standards for financial transactions under a shared data processing system and worldwide communications network. The first SWIFT message was sent in 1977.
Since then, SWIFT has become the primary global system for international funds transfers. More than 11,000 SWIFT member institutions in over 200 countries sent over 35 million transactions per day through the network in 2020. The organization recorded an average of 41.8 million messages per day on a year-to-date basis as of July 2021[i] with an estimated value of $5 trillion per day in funds movement.
SWIFT is solely a messaging system. It does not perform any type of settlement between financial institutions. This is an important distinction from Fedwire and CHIPS, the two other most widely used wire transfer systems. To further understand this difference, let’s explore some of the fundamentals of electronic funds transfers.
Fundamentals of Funds Transfers: Message and Settlement
Any type of electronic funds transfer has two primary components: (1) the message; and (2) the settlement of the payment.
A wire transfer message is a set of instructions specifying who is sending the money, to whom, through what financial institutions. The message might also include additional information about the purpose of the payment, special posting or notification instructions, etc.
Settlement is the process by which the receiving financial institution obtains the money in order to disperse it to the recipient. For example, imagine Bank A’s customer is sending a $10,000 wire transfer to Bank B’s customer. Bank A sends a message to Bank B stating “post a credit to your customer’s account for $10,000 coming from our customer on this date.” When Bank B posts this credit to its customer’s account, Bank A owes Bank B $10,000. The wire transfer system used by these two banks determines how the message is transmitted and how Bank A and Bank B settle up the amount owed.
Forms of Settlement
Settlement of payments between financial institutions occurs in one of two primary ways:
With real-time gross settlement, money is transferred instantaneously from one financial institution to another. Each transaction is settled on an individual basis without netting of incoming and outgoing payments. Once completed, the payment is final and irrevocable. Most real-time gross settlement systems are operated by a country’s central bank. In the United States, the U.S. Federal Reserve is the central bank, and its real-time gross settlement system is called Fedwire. Other similar systems include the United Kingdom’s CHAPS, and Europe’s TARGET2 system.
In contrast, deferred net settlement typically occurs directly between financial institutions, using accounting entries posted to what are commonly known as correspondent accounts. These correspondent relationships established between financial institutions are the foundation on which SWIFT operates.
Correspondent Accounts and Relationships
Once two financial institutions have established a correspondent relationship, each creates accounts on its books representing (1) funds due from the other institution (a receivable, or asset) and (2) funds owed to the other institution (a payable, or liability). These accounts are often referred to as “nostro” and “vostro” accounts. These are Latin words meaning “ours” and “yours” respectively. A nostro account would be a receivable (“our” money) and a vostro account would be liability (“your” money).
This illustration depicts how two institutions, Bank ABC and Bank XYZ, would make entries to their respective correspondent accounts for wire transfers sent or received by their respective customers:
Financial institutions entering into correspondent relationships perform extensive due diligence on one another, including evaluating the institution’s creditworthiness and stability. This is because a nostro account represents, in effect, an extension of credit from one bank to another.
Mechanics of a SWIFT Wire Transfer
Remember, SWIFT is only a messaging system – no settlement is involved. The two key elements of the SWIFT system are (1) the financial institutions’ identifiers and (2) the message types.
Financial Institution Identifier: BIC
Each financial institution involved in a SWIFT message is identified by a “BIC” or Business Identifier Code.
The BIC is an alpha-numeric code of eight to eleven characters. Financial institutions may establish different BICs to use with specific types of messages, or for other internal accounting purposes. For example, Bank of America N.A. has forty-four BICs. Here are three:
The first four characters of the BIC make up the business party prefix (“BOFA”), followed by a two-character ISO standard country code (“US”), and then a two-character business party suffix (“3N” “3D” “6S”). The last three characters in the BIC are an optional branch identifier, used to for specific locations, departments, services, or units of the same business party (“INQ” “FPS”). If not used, these remaining characters may be populated with “XXX” such as in the third BIC shown above.
SWIFT provides a searchable database of all BICs used on its network, available at https://www2.swift.com/bsl/. The database provides the full name of the institution, its address, and the meaning of any branch identifier. For example, the Bank of America branch identifier “FPS” represents “funds processing system” according to the SWIFT database.
SWIFT Message Types
The SWIFT system is used not only for payments, but also for many other types of transactions and communications between member financial institutions. The nine high-level categories (or series) of SWIFT messages are as follows:
Each specific message type begins with the letters “MT”. Within each series are many sub-categories of messages. For example, the most commonly used message types in the MT-100 and MT-200 series include:
MT-103 Single Customer Credit Transfer MT-200 Financial Institution for its Own Account
MT-107 General Direct Debit Message MT-202 General Financial Institution Transfer
MT-199 Free Format Message MT-299 Free Format Message
It’s estimated that 70% to 80% of all SWIFT messages are for payments. Yet as illustrated above, messages could be related to foreign exchange, export letters of credit, securities trades, and others, including general correspondence between banks.
A SWIFT MT-103 Message Example
Here’s an illustration of a SWIFT MT-103 Single Customer Credit Transfer, using fictitious data:
The SWIFT message has a Header section, identifying the sender and receiver of the message. This is followed by the Message Text section where all the details of the transaction are included. Every field on a SWIFT message has a numeric identifier. For example, in the message above, field 32A includes the transaction date, currency and amount.
The fields of greatest interest to compliance professionals, particularly for suspicious activity monitoring and sanctions screening, are as follows:
Because this funds transfer involves multiple banks, two SWIFT MT-103’s will ultimately be created: the first one, as illustrated above; and then a second message from Royal Bank of Canada to Citibank Canada. The entire transaction is diagrammed below:
SWIFT Cover Payments
Over the years, one particular type of SWIFT message, the MT-202 General Financial Institution Transfer – essentially a bank-to-bank transfer – became fraught with issues involving potential money laundering and sanctions violations when used for cover payments.
What is a SWIFT cover payment?
When the originator’s bank and the beneficiary’s bank don’t have a correspondent relationship established, each must involve their own correspondent bank in order to transfer the funds.
To complete the funds transfer, two separate SWIFT messages are used. First, an MT-103 Single Customer Credit Transfer is sent by the originator’s bank directly to the beneficiary’s bank, advising them of the details of the transfer to their customer. However, because these two banks don’t have a correspondent relationship, the payment cannot be settled between them. Instead, both banks must use intermediaries.
Historically, an MT-202 General Financial Institution Transfer message was used to instruct the intermediary/correspondent financial institutions to make the necessary settlement entries for the payment.
Because it’s designed as a bank-to-bank payment message, the MT-202 has no information about the actual originator and beneficiary in the underlying MT-103 payment message. Instead, it presumes the sending bank is the originator, and the receiving bank is the beneficiary.
This absence of underlying transaction details led to heightened concerns about money laundering and sanctions violations, because the intermediary banks that were moving money across the banking network could not perform anti-money laundering monitoring, sanctions screening, or other risk-based analysis to comply with their specific banking laws.
An originating bank could use the “cover method” (meaning an MT-202 and an MT-103) to deliberately hide the true originator and beneficiary of the transfer from the intermediary banks. This was of particular concern for U.S. intermediary banks processing payments for originating and/or beneficiary banks that were intentionally evading OFAC sanctions.
In response to these concerns, in 2009 SWIFT created a new payment message designed specifically for cover payments: the MT202 COV. This message type includes all the detailed information from the underlying MT-103, thereby allowing the intermediary banks full access to all the payment information. SWIFT participants are now prohibited from using the MT-202 for cover payments.
Cover Payment Illustrations
This illustration depicts a typical cover payment scenario. Mitsubishi UFJ’s customer is sending a wire transfer to a beneficiary in Bosnia whose account is at ASA Banka. Mitsubishi and ASA Banka do not have a correspondent relationship. Mitsubishi sends an MT-103 payment message to the beneficiary in the local currency, which is the Bosnian mark (BAM); however, ASA Banka replies that it wishes to be reimbursed for this payment in the equivalent U.S. dollars.
Mitsubishi’s correspondent is Wells Fargo, and ASA Banka’s is JPMorgan Chase. A series of MT-202 COV messages are sent between Mitsubishi, Wells Fargo, JPMorgan Chase, and ASA Banka to complete the settlement of the payment to ASA Banka in U.S. dollars.
Details of the entries in the respective intermediary banks’ correspondent accounts is illustrated below:
Wire transfers are heavily utilized in the layering phase of money laundering. SWIFT wire transfers are the primary method of moving funds across borders, resulting in a higher risk for both money laundering and economic sanctions violations. Accordingly, compliance professionals should understand the fundamentals of SWIFT messaging, payments, and the underlying correspondent relationships that facilitate them, in order to more effectively monitor for and evaluate suspicious customer activity and sanctions violations.
[i] SWIFT.com. Monthly FIN Traffic Evolution July 2021 YTD. https://www.swift.com/about-us/discover-swift/fin-traffic-figures
[ii] U.S. based CHIPS utilizes a hybrid settlement system combining real-time gross and daily net settlement, which is beyond the scope of this article. Further detail on CHIPS may be found at www.theclearinghouse.org.
[iii] Formerly known as a Bank Identifier Code, or simply “SWIFT code,” the BIC format has been standardized under ISO 9362 and renamed Business Identifier Code.