European banks still in Russia: should they stay or should they go?

Banks still with operations in Russia should break their assets down to zero, walk away and be done with it, says Bill Browder, a former Russian investor turned author and critic of the Kremlin.

“Some banks pulled out [of Russia] a long time ago, but a lot of people didn’t and now they’ve been caught with their pants down,” says Mr Browder, CEO and co-founder of Hermitage Capital Management, an emerging markets fund which previously invested in Russia. “The right thing to do is just sell or alternatively stick it in a trust and allow any benefits that accrue to fund victims of the war in Ukraine.” 

Ukraine’s central bank has accused some of the European banking groups still operating in Russia of dragging their heels in reducing their exposure.  “More than one year into the war, only one bank has completely left the aggressor’s market, while the majority of Russian-based subsidiaries have been reluctant in this regard and are reducing their exposure without much speed,” a press spokesperson for the National Bank of Ukraine (NBU) told The Banker. 

France’s Société Générale (SocGen) is one of only a small handful of foreign banks that have successfully exited the Russian market via a subsidiary sale. It sold its Russian subsidiary, Rosbank, to Russian conglomerate Interros Capital, controlled by Russian oligarch Vladimir Potanin, last May, but took a net income hit of €3.2bn. 

Are European banks in Russia dragging their heels?

Despite earlier assurances from banking groups such as Raiffeisen Bank International (RBI), Intesa Sanpaolo, OTP Bank, ING Bank, and Credit Agricole that they “continue to study all strategic options for the future of their business in Russia, including options for exiting the market”, the NBU press spokesperson claims that European banks such as Raiffeisen and OTP Bank of Hungary are still making business development efforts in the Russian market and not reducing their exposures as significantly as other international banks. 

Raiffeisen is the 10th largest bank by assets in Russia, and given that its Russian operations have not been sanctioned, unlike other major Russian banks, it will become increasingly important for the Russian banking sector, says Pedram Moezzi, economist for banking risk at S&P Global Market Intelligence.

A senior executive from Raiffeisen Bank recently told the FT that “it now handles 40–50 per cent of all money flows between Russia and the rest of the world”. Raiffeisen Bank is classed as “systemically important” to the Russian banking system, and last year earned €2bn in net income from its Russian operations (more than half of the Group’s total net income of €3.6bn for 2022). Net fee and commission income increased more than four times year on year from €420m in 2021 to €2008m in 2022. However, this increase was largely attributed to foreign exchange business and currency effects. 

According to RBI’s preliminary 2022 full-year results presentation, loans to customers in Russia declined by 30% year on year in local currency terms and are expected to remain around current levels. RBI’s net cross-border exposure to Russia risk fell from €600m in March 2022 to €217m as at January 20, 2023, but the NBU says the drop in credit exposure was primarily due to exchange rate fluctuations. 

The bank cannot repatriate profits from its Russian operations due to international sanctions. But the NBU spokesperson says: “The growth in the Russian-based bank’s profits is translating directly into tax base increases and the group’s potential contributions to the Russian state budget.” The spokesperson also claimed that the bank had posted 50 job openings, the vast majority of them in partner network development and IT products. 

Lucinda Ritchie, country risk analyst at Fitch Solutions, says the war in Ukraine has caused indirect disruptions to Russia’s banking sector, including shortages of IT professionals. Ms Ritchie says the Russian Ministry of Communication estimates more than 100,000 IT professionals left the country last year, equivalent to 10% of the entire IT workforce. 

RBI says it is “assessing all strategic options” for the future of its bank in Russia, up to and including “a carefully managed exit”. As the situation in Russia is very complex, an RBI spokesperson told The Banker it had hired external parties to support it in exploring various options for its Russian bank.

“Looking forward, I assume that the rationale an institution like RBI is betting on is that eventually the conflict between Russia and the West eases at least to the point where they can repatriate the profits that are currently stuck in Russia,” says Thorsten Beck, professor of financial stability and director of the Florence School of Banking and Finance.

“Personally, I think that is a miscalculation.”

In its Q4 2022 results, RBI estimates that “withdrawing from the Russian banking sector, at a price-to-book ratio of zero (a write-off and no Russian subsidiary sale income) would imply a capital hit of 2.5 percentage points, which would see its common equity Tier 1 ratio fall to 13.5% from 16% at the end of 2022. 

The NBU says it is also seeing a slow reduction in exposure to the Russian market by Hungary’s OTP Bank, which cannot indicate the bank’s intention to leave the market. It claims that OTP, one of the top 50 largest Russian banks, “is ramping up corporate and SME deposits in an increase that is visible even after adjusting for the variation in exchange rates”. 

In its full-year 2022 results, OTP says the profit of its Russian bank fell by 57% in local currency terms. “In line with the new strategy, the corporate loan portfolio and intragroup funding has been consciously reduced,” the bank states. Gross customer loans fell by 12% year on year to Rbs152bn ($1.99bn), and corporate loans by 75% to Rbs7bn. However, customer deposits increased 19% year on year to Rbs112bn. 

The NBU claims the deposit rates that OTP Bank is offering its clients are higher than the average across Russian banks. “Such a pricing policy indicates that OTP Bank is actively raising funds in the Russian market and continuing to do business in Russia,” the spokesperson says.

Is an orderly exit from the Russian market possible?

A spokesperson for OTP Bank in Hungary told The Banker its activities in Russia are focused on retail lending and that it stopped lending to corporates after the outbreak of the war. “The OTP Group is considering all strategic options for the future of its Russian bank, including the possibility of a sale,” the spokesperson says. 

In preparation for a possible orderly exit from the Russian market, it engaged Rothschild Martin Maurel as transaction adviser to map potential buyers. The bank would not disclose if it is in discussions with any potential buyers. However, the spokesperson says a decree of Russian president Vladimir Putin on August 5, 2022 prohibited transactions in shares of banks in Russia owned by “unfriendly” states. 

The list of banks subject to the ban, which includes the Russian subsidiary of the OTP Group, was approved by Mr Putin on October 26, 2022. “This regulatory circumstance limits our sales opportunities to almost zero,” the spokesperson says.

The decree imposes a certain number of conditions with which sellers must comply, which, according to George Voloshin, a global anti-financial crime expert at the Association of Certified Anti-Money Laundering Specialists, means banking assets cannot be as easily sold in the same way SocGen was able to dispose of Rosbank. “They’ve also introduced an exit tax of 10% which sellers must pay to the [Russian] government when they sell their assets in Russia,” he says. 

One of the big foreign bank subsidiary sales that fell through as a result of the decree was HSBC’s proposed sale of its Russian subsidiary to Russia’s Expobank. The deal was agreed in July, but received negative signals from the Russian authorities. “In their [HSBC’s] full-year annual report as of 2022, HSBC is estimating a $300m loss with regard to a possible exit from the Russian sector,” says Mr Moezzi. “However, they're basing this on [receiving] the necessary approval from the regulatory and government authorities, which obviously includes the Russian president.” 

Mr Moezzi says foreign banks in Russia will continue to find it difficult to exit the market, given the fact that they need to receive the approval of the Russian president. “Market valuations are also likely to be below balance sheet value, and there’s a restricted pool of potential buyers. Foreign investors are unlikely to want to enter the Russian sector and take over foreign-owned banks at a time of increased public scrutiny.” 

Walking away or just writing off their Russian operations is not an option that seems palatable to banks either. “A disorderly exit, or termination of ownership, would mean a significant aid for the Russian economy,” says OTP Bank’s spokesperson, “as depositors would have to be repaid, while loan recovery would be impossible. This explains why, unlike some industrial companies, no bank has opted for this type of disorderly exit.”

Nicolas Véron, a senior fellow at Brussels think tank Bruegel and the Peterson Institute for International Economics in Washington DC, says the European Central Bank has been making increasingly loud noises in terms of asking banks like Raiffeisen to reconsider its Russian operations and the profits they are making in Russia. “I don’t think there is an elegant or neat solution for these banks,” says Mr Véron. “At some point, there has to be some pain.” 

How could European banks reduce their exposure to Russia?

Andrea Enria, chair of the European Central Bank’s Supervisory Board, stated in a press conference recently that while the window for exiting the market is closing because the Russian authorities have become more hostile to requests from European banks to exit and sell the business, many banks have reduced provisions significantly for the cross-border business, or had started a sort of “dual steering” – keeping their prudential and risk management of the Russian subsidiary separate from the rest of the group.

Other banks have managed to offload portfolios. On October 28, Citi announced that it had sold a portfolio of ruble-denominated personal instalment loans to Uralsib, a Russian commercial bank. It also agreed to transfer a portfolio of ruble-denominated credit card balances to Uralsib, subject to customers’ consent. The bank says it is on track to end institutional banking services in Russia by the end of the first quarter this year. 

Italy’s Intesa Sanpaolo, which operates a small commercial bank in Russia, says it is very close to its goal of reducing its Russian exposure to zero. “We immediately halted in February all new loans and investments related to Russia,” a spokesperson says. “Since then, we have been unwinding our previously-existing exposure, reducing it by over two-thirds in just a few months. Now, exposure to Russia is below 0.3% of our total customer loans. The trajectory is clear.”

In addition to scaling down their Russian operations, the NBU says foreign banks can leave Russia via voluntary liquidation or initiate investment arbitration against the Russian Federation if the banks run into actual problems with enforcing their rights.

It says it is important to continue the collective search for mechanisms to encourage international banking groups to exit the Russian market. One such mechanism, it proposes, is to set increased capital requirements for parent banks in view of the risks of European banking groups’ existing assets in Russia.

At the end of the day, different banks will have different approaches in Russia, says Mr Browder. “Some are hoping that if they can keep their head down, the whole thing will blow over and they can have good business in Russia afterwards. Some are afraid of violating any Putin decree because they don’t want personal cases opened up against them. Some are just paralysed by fear. These are not people who ever imagined, in spite of all the warnings, that they would be in the middle of this murderous war where they could get killed in the crossfire.”