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CIPS - Chinese alternative to SWIFT and a step towards dedollarization
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CIPS - Chinese alternative to SWIFT and a step towards dedollarization

created Forex ClubApril 20 2023

Recently, social media circulated information that Brazil has signed an agreement with China to settle trade between the two countries bypassing Western systems. The Brazilian bank BOCOM BBM, which is a subsidiary of Bank of Communications, has been directly connected to CIPS. It is the first Latin American bank connected to a Chinese clearing house. Thanks to this transaction, entities from Brazil and China will be able to carry out the transaction without having to convert the transaction into dollars. What does it look like in practice and what exactly is it? CIPS?

War changes the rules of the game

What happened in 2022 will affect international, trade and financial relations for many years to come. After the sanctions imposed on Russia, as a result of its aggression against Ukraine, many countries realized that relying only on SWIFT, CHIPS, the dollar and the euro could lead to a real tragedy in a situation of conflict "with the West". Russia's disconnection from SWIFT has left Russian banks disconnected from most operations with Western financial institutions. Moreover, the Central Bank of Russia would not be able to draw back its foreign exchange reserves, which were held on foreign deposits.

Many countries have started to look towards China as an alternative to SWIFT. Of course, this does not mean that all countries will suddenly abandon SWIFT in favor of a Chinese alternative. However, there will be a diversification of foreign exchange reserves and payment settlement methods. However, it is worth remembering that this is a long-term process. People who believe that it will happen in a few quarters live in their own world. CIPS offers an alternative to Western clearing houses. China, due to its economic potential, makes it possible to build the appropriate infrastructure to create an alternative world of payments.

The more trade takes place without SWIFT and CHIPS, the less effective the economic sanctions imposed by the United States and the European Union will be. On the other hand, other countries will experience sanctions from China in the future. After all, China is increasingly defending its interests and applying limited boycotts. An example was the embargo on Australian wine or agricultural products.

What is SWIFT and CHIPS

To understand what CIPS is about, you also need to explain what SWIFT actually is. It is a system for transferring information between banks. Banks and other financial institutions simply transmit messages using standardized codes and data formats. Standardization of information facilitates transactions and reduces costs. Thanks to this information, banks reduce or increase funds in customer accounts. SWIFT itself is not eternal. It was established in 1973 and its headquarters are in Brussels. The manipulation is that SWIFT only allows payments in dollars. For example, in April 2022, 41,8% of payments are processed in dollars and 34,7% in euros. Transactions settled in RMB accounted for only 2,1%.

SWIFT is also a tool that allows the government of the United States and other large countries to check whether sanctions are being respected. How can a bank be excluded from SWIFT? By voting by members of the organization. Many banks, fearing the imposition of sanctions by the United States (e.g. a ban on operating in the US), can vote as the US government wants.

Of course, disconnecting from SWIFT does not mean the end of the world. However, it results in significantly longer operations, increased risk of errors and higher costs. You can therefore send messages between banks using telephone lines or encrypted messages. Another solution is to use alternative forms of sending messages between banks. This can be e.g. CIPS.

China is also trying to develop its own clearing system. However, for the time being, China has much less developed solutions than, for example, the American CHIPS (US Clearing House Interbank Payments System. CHIPS was founded in 1970 by eight members of the New York Clearing House Association. Currently, this institution has about 50 members. It is a private institution whose shareholders are direct members of CHIPS. It is worth recalling that CHIPS is supervised by the FED.

The CHIPS institution itself is sometimes called a “netting engine”. This has to do with the fact that the organization compiles the accounts owed and has. It then calculates which bank owes a certain amount of money. It uses a compensation model for this, i.e. it reduces the number of transfers in the system. The settlement system uses FED accounts, which are settled via Fedwire. Transactions settled by CHIPS are always settled in dollars. Of course, there are other clearing houses as well. One of them is CHAPS (Clearing House Automated Payment System). It is the clearing houses that are one of the main foundations of the strength of the dollar.

Of course, countries can set up their own clearing houses to support payment processing in their own currency. However, this requires the other party to the transaction to accept this type of payment. For example, the agreement between Saudi Arabia and China to settle oil in Chinese currency does not mean the end of the dollar. Saudi Arabia will simply keep part of the funds in the papers of the People's Republic of China.

What is CIPS?

CIPS is short for Cross-Border Interbank Payment System. It is a payment system that offers clearing and settlement services for international payments using RMB. So it is creating a payment system that works "next to" SWIFT. This can be called protecting the People's Republic of China against a possible "nuclear option", which is cutting off the country from SWIFT, i.e. the international trade settlement system, and CHIPS (the leading clearing house). The very concept of CIPS clarified in 2012 when the People's Bank of China (PBOC) began the first phase of the development of this system. After three years, he started operating on the market. It was an important step on the way to the development of the payment infrastructure by the Middle Kingdom.

Although the topic has become loud in the last few weeks, CIPS itself was created in 2015 how to internationalize remnimbi. For China, another important feature of CIPS is that Chinese banks and companies can transact without the risk of the transaction information reaching the United States. The aforementioned settlement system is another pebble to the de-dollarization of the world economy. This can be seen in the trade between China and Russia. In 2020, 17,5% of trade value was settled in RMB. Six years earlier it was 6%. It should be noted that Russia has also been developing its SPFS payment system since 3,1, but it is used predominantly by domestic financial institutions. The example of Russia shows that the mere creation of a system is not enough to be independent. We still need to find people willing to join the system.

It should be noted that CIPS still relies heavily on SWIFT for the transfer of financial information across borders. However, it has the potential to operate independently of SWIFT in this regard. This means that CIPS may be insensitive to any sanctions from the "West" on the settlement of foreign transactions. How painful it is, Russia found out after the attack on Ukraine. Despite the fact that China creates its own system, it is still deepening its cooperation with SWIFT. As of 2019, the messaging system allows this to be done using Chinese symbols.

CIPS and CHIPS - comparison

In 2015, the People's Bank of China introduced CIPS, or Cross-Border Interbank Payments System. It is an independent institution overseen by the People's Bank of China (PBoC). It is worth noting that foreign banks are also shareholders in CIPS such as HSBC, Standard Chartered, Bank of East Asia, DBS Bank, Citi, BNP Paribas and Australia and New Zealand Banking Group. CIPS processed transactions worth $2021 trillion in 12,7. 1280 financial institutions from 103 countries and regions participated in the transactions. This means an increase of 75% y/y. 30 banks are involved in CIPS transactions Japan, 23 Russian banks and 31 banks from Africa. CIPS is also used to settle transactions related to the New Silk Road.

CIPS payments are made in Chinese currency. It should be noted that direct members (more than 70 institutions) can send messages both via the messaging system organized by CIPS and SWIFT. It is worth noting that as much as 80% of the payments settled by CIPS go through SWIFT.

The CIPS system cannot yet match CHIPS in terms of turnover, number of transactions and affiliated institutions. For example, in 2022, 11 financial institutions were connected to CHIPS. At the same time to the Chinese system 000 1. In March  In 2022, the value of transactions in CIPS amounted to USD 45,6 billion. At the same time, CHIPS settled transactions worth $1 billion. However, CIPS is on the rise. Russia's invasion of Ukraine helps in this. Cut off from the "west", Russia was looking for buyers for its oil. It agreed to settle prices in Chinese currency and make transactions through CIPS. Interestingly, China did not agree to settle transactions in rubles. China therefore wants to strengthen its own "anti-dollar camp", not necessarily to support other countries fighting for de-dollarization.

Summary - Long March for CIPS

Russia's invasion of Ukraine has prompted "Western" countries to take unprecedented measures. Russia's foreign exchange reserves, which were held in American and European institutions, were frozen. Moreover, Russian banks have been disconnected from SWIFT. At the same time, transactions were not settled by CHIPS or European clearing houses. All this was possible because of that SWIFT it is de facto controlled by American and European banks. CHIPS, on the other hand, is supervised by American institutions.

Scale of sanctions, financial “nuclear option” caused the countries of the South to look for alternatives to SWIFT and CHIPS. The natural leader is China. However, it is worth remembering that the dollar and euro will not be replaced by the Chinese currency. At most, an alternative system to the Western one will be created. An insurance policy against Western sanctions. It is worth noting that SWIFT and CIPS have been working together for years. In 2016, a letter of intent was signed regarding the adoption of the ISO200022 standard by CIPS. However, the internationalization of the renminbi will require more free movement of capital. Then the People's Bank of China will have to free the RMB exchange rate. So far, there is a very long way to go. So it is a road for many years if not decades.

There is still on the horizon CBDC (Central Bank Digital Currency), which can also mess up the financial system. But that is a topic for a separate article.

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Forex Club
Forex Club is one of the largest and oldest Polish investment portals - forex and trading tools. It is an original project launched in 2008 and a recognizable brand focused on the currency market.