SWIFT Payments: How does SWIFT work?
Feb 17, 2023 • 7 min read
As a small business, you rely on your bank to manage your bills, expenses, payments and more. Most small businesses also rely on their banks to also process international wire transfers to pay employees, suppliers, and manufacturers that are overseas.
Banks normally use SWIFT to process these transactions.
Here we will talk about:
- What is SWIFT?
- How does the SWIFT system work?
- Who owns and runs SWIFT?
- How do you send money with SWIFT?
- Managing your international payments to employees
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What Exactly is SWIFT?
At its core, SWIFT is a financial messaging system. It operates on a network of major banks around the world. These banks use SWIFT to communicate information on financial transactions in a way that is standardized and secure.
If you’ve ever needed to make or receive an international money transfer, you might have heard of SWIFT and its network.
Since most large banks use SWIFT, we’ve decided to explain how it works so that you can know more about what goes on during your next international transaction, including the reasons behind longer waiting periods and added fees.
Who Owns and Governs SWIFT?
SWIFT, or the Society for Worldwide Interbank Financial Telecommunication, is known as the leading provider of financial messaging services. It is headquartered in Belgium and has been around since the early 1970s.
It is a cooperative that is controlled and owned by its shareholders (financial institutions) which represent around 3,500 firms from around the globe.
SWIFT is governed by a 25-person board of independent directors (elected by the shareholders and representing banks from around the world) and overseen by the board, National Bank of Belgium and the G-10 country central banks.
SWIFT does not make any decisions on sanctions as it serves as a neutral utility. However, it is incorporated under Belgian law so it must comply with EU regulations, as confirmed by the Belgian government.
How Does SWIFT Work?
SWIFT was created to help banks communicate faster and more securely among themselves when dealing with the processing of international payments.
It is used to communicate money transfers between two banks by channelling the message containing payment instructions from the bank of the payer (the issuing bank) to the bank of the beneficiary.
All the banks involved in the process will then move funds from one account to another based on an underlying network of accounts called Nostro/Vostro accounts.
FYI
Nostro/Vostro accounts are used when one bank has money deposited in an account opened with another bank with the intention of carrying out international transactions.
The words are used when one bank keeps money at another bank in a correspondent account often called a Nostro or Vostro account.
Both institutions need to keep records of how much money is being kept by one bank on behalf of the other. This sees two mirroring sets of ledgers known as the Nostro and Vostro accounts.
In a Nutshell…
SWIFT is used to communicate international money transfers between two banks.
If the two banks have a direct commercial relationship (if they have commercial accounts with each other), the transfer is completed as soon as the SWIFT message has been received. The money moves from Person A’s personal account to Person B’s account through the banks’ commercial accounts, and the banks take a fee from this.
If the two banks do not have any commercial accounts with each other – an intermediary bank will have to help by facilitating the process. This involves an additional fee being charged to you.
If the transfer involves two currencies, one of the banks will carry out the currency excha
How does the system work?
The SWIFT network does not actually transfer money. Instead, it communicates transaction orders between two banks using SWIFT codes.
SWIFT assigns every financial organisation a code to uniquely identify a financial institution. The code, which usually has eight or eleven characters, is called the SWIFT code, ISO-9362, or the BIC code.
The SWIFT network has standardized the format for the IBAN (International Bank Account Number) system and owns BIC (Bank Identifier Code) format, which are used for actual funds transfer.
SWIFT BIC and IBAN codes both facilitate international money payments
During an international transfer, the IBAN code identifies both the bank and a specific account at the bank. The SWIFT code, also known as the BIC code, identifies only a specific bank during a transfer.
As we said, the SWIFT network has standardized the formats for the IBAN system and in its role of ISO registration authority, SWIFT issues BICs.
The US does not use the IBAN code domestically (although it does recognize the system and process IBAN payments when handling an international transaction using IBAN.)
Instead, US banks use ABA routing numbers for domestic transfers and SWIFT codes for international payments.
How do SWIFT payments work?
To see what goes down during a SWIFT transfer, let’s look at a simple example:
Let’s say Anette lives in the US and wants to pay $1,000 from her US bank account to Bob’s bank account in New Zealand.
There are two ways this can take place depending on whether or not their banks already have commercial accounts with each other.
Scenario 1 – Anette’s bank and Bob’s bank have a direct commercial relationship
If the two banks have a direct commercial relationship (that is if they have commercial accounts with each other), the process will be faster and easier.
- Anette’s bank will send payment instructions or a SWIFT message to Bob’s bank
- Anette’s US bank will debit her account by $1,000 (money goes out)
- Anette’s bank will credit the commercial bank account held with Bob’s bank (money coming in)
- Bob’s bank will credit his personal account (money comes in)
Scenario 2 – Anette’s bank and Bob’s bank do not have a direct commercial relationship
The process can get a bit more complicated when the two banks do not have any commercial accounts with each other.
This is where intermediary banks (also known as correspondent banks) are used to facilitate the payments. The intermediary financial institution is the bank in which the other two have commercial accounts.
In this case,
- Anette’s bank will send payment instructions or a SWIFT message to Bob’s bank, and they will find the right intermediary bank (let’s call this Bank IB)
- Following this, Anette’s bank will debit her account by $1,000 (money leaving her account)
- Anette’s bank will also request Bank IB to debit their commercial account by $1,000 and credit the commercial account of Bob’s bank
- A small fee is charged by Bank IB for acting as the intermediary (in this example, let’s say $5) on the transferred amount, and Bank IB credits the commercial account of Bob’s bank by $995.
- Bob’s bank will now credit Bob’s personal account by $995 (money coming in)
These additional steps are why things take a little longer in this scenario (around 3-5 business days) and fees apply.
What happens if Anette’s bank and Bob’s bank don’t have commercial accounts with an intermediary bank?
This will mean that more than one correspondent bank needs to be involved in the process.
Unfortunately, this would also mean more fees and processing time for your transfer.
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