According to a Reuters report,  “Pro-Moscow rebels, backed by what NATO says is the open participation of Russian troops, pressed on with their offensive over the weekend after restarting the war in eastern Ukraine with the first all-out assault since a truce five months ago”.

The resurgence in the conflict means western leaders are again discussing the possibility of a new round of sanctions against Russia as a way to isolate the country and drive a policy change. "If the Russian government cannot prove that it is making verifiable progress towards a de-escalation of the situation, we'll have to talk about more severe sanctions unfortunately," said German politician Karl-Georg Wellmann, a foreign policy specialist for Chancellor Angela Merkel’s Christian Democrats, according to Reuters. (To learn how Russia has been affected by the sanctions that have so far been imposed, see article: How US & European Union Sanctions Impact Russia.)

Iranian sanctions are the template

To get an idea of what steps the west might take next, one needs only look at the list of sanctions that have been implemented against Iran following the 1979 revolution that set the stage for strained relations between Iran and the U.S..  A summary of current sanctions imposed on Iran is available on the US Treasury website. The list includes steps such as preventing Iranian financial institutions from accessing western capital markets, or impeding the use of advanced oil drilling equipment by the Iranian oil sector. These steps have also been taken against Russia.

One sanction that has not yet been applied against Russia that was applied to Iran in 2012 is a move to ban financial institutions of the country from using the SWIFT interbank payment system. According to Bloomberg Business Week, “The Belgium-based Society for Worldwide Interbank Financial Telecommunication system, known as SWIFT, is a secure messaging system used by more than 10,500 banks for international money transfers. Without it, Russian banks and their customers couldn’t readily send or receive money across the country’s borders, which would wreak havoc on trade, investment, and millions of routine financial transactions. SWIFT has to comply with EU decisions because the organization is incorporated under Belgian law.”

Banning Russian financial institutions from using SWIFT would make it harder for Russian oil companies to process their US dollar payments for oil. This seems to be a particular concern for Russia. Speaking at a panel in Davos,  Andrei Kostin, chief executive of VTB, Russia’s second-largest bank, said that excluding the country from the SWIFT banking payment system would be tantamount to war. The idea of banning Russian banks from SWIFT was proposed during the summer of 2014, but was considered too harsh at the time. With tensions rising again, however, the idea could be reintroduced.

According to the FT, Russian banks have already created a domestic alternative to the SWIFT system following the announcement by Mastercard (MA) and Visa (V) that they could no longer support bank cards being used in Crimea, following US sanctions imposed earlier this month. Russian banks currently lack an equivalent system to process the international payments that are vital to the country’s oil industry. (For a background on Russia's key sources of revenue, see article: How Russia Makes Its Money -- And Why It Doesn't Make More.)

Debt-Servicing in Jeopardy

If the US and EU press ahead with the idea of cutting Russia off from SWIFT, the country’s key foreign exchange earners in the oil and gas industry would not be able to process US dollar payments that are vital to ensuring enough dollars are available for the servicing of debt.  Analysts estimate that Russian corporations and banks will need to repay or refinance up to USD $100 billion in 2015. Part of this money was supposed to come from the dollar revenues of the oil and gas sector. Normal business would be severely disrupted if Russian companies are unable to process their payments, and such circumstances could increase the risk of default and spark a new wave of pressure on the ruble.

Seen from this perspective, it is easy to understand why the Russian authorities are nervous. Whether they are nervous enough to change their policy in Ukraine is another matter. Either way, the one thing that seems assured is another round of sanctions from the west that may or may not include a ban on Russia's use of SWIFT. If the west adopts such an approach, expect a swift answer from Russia.

The Bottom Line

US president Obama has rightly ruled out direct military conflict as a way to resolve the crisis in Ukraine. This means western leaders will need to find other means to achieve their policy goals for the region. Since current financial and trade sanctions targeted at Russia’s banking and oil sectors seem to be ineffective so far, any new sanctions will need to exact a higher cost for Russia's present actions. Sanctions that could have the right punitive effect could include cutting Russia’s financial lifelines to the rest of the world.  (For related reading see article: Investing In Russia: A Risky Game?)