cover feat

International banks are looking to shut up shop in Russia in response to the heavy sanctions imposed on the country, but they will face numerous challenges in doing so, even after they have made their exit. Burhan Khadbai reports.

Over the past few months, almost every major international bank with operations in Russia has declared that they are considering exiting the country, if they have not left already. The severe international sanctions imposed on Russia in response to its invasion of Ukraine, coupled with the ethical and reputational risks, have made it extremely challenging for banks to stay.

“There are challenges for international banks complying with the sanctions as the sanctions are still being worked out in detail, and [in the past, we’ve seen] banks receiving large fines for not carrying out the sanctions correctly,” says Elisabeth Rudman, head of the European financial institutions group at DBRS Morningstar.

“A number of European banks have significant subsidiaries and operations in Russia which, if they decide to close down, will result in a cost to them,” says Ms Rudman. “But these costs can be managed as they are large banks. It will be a big one-off hit. There is also the broader impact across the banking system which depends on what happens to the economy in Europe. We’ve already got a post-Covid situation with higher inflation and volatility in asset prices.”

Cutting ties

On April 11, Société Générale became the first Western bank to announce the sale of its Russian subsidiary — the entire stake in Rosbank to Interros Capital, an investment firm founded by Russian oligarch, Vladimir Potanin — as it said would cease its banking services in Russia.

Questions were being asked after Société Générale remained coy on the future of its Russian operations. It has the biggest exposure to Russia of the Western banks operating in the country, due to its Rosbank subsidiary, one of Russia’s largest lenders. The French bank’s total exposure to Russia stood at €18.6bn at the end of December 2021, of which €15.4bn was derived from Rosbank.

After Société Générale, the other European banks with the biggest exposures to Russia are Raiffeisen Bank International (RBI; $12.2bn) and UniCredit ($13.3bn). Meanwhile, Citi ($9.8bn) has the biggest exposure among US banks in the country. Overall, foreign banks have exposure of $121bn in Russia, comprising $67bn of international claims and $54bn of local claims, according to statistics from the Bank for International Settlements at the end of September 2021.

“The bank most reliant on Russia for its business is RBI,” says Ms Rudman. “But for large banks like Société Générale — which have very broad and diversified activities in a lot of counties and business lines — it’s not helpful to have this kind of event [but] it is manageable.”

Société Générale and UniCredit’s exposure to Russia is limited at around 2% of the banks’ total exposure. However, RBI’s exposure to Russia represents more than 9% of the bank’s total exposure, with the Austrian bank generating almost 35% of its net profit from the country.

As a result, RBI has been the hardest hit among Western banks in Russia with its share price having fallen by more than 50% since Russia’s invasion
of Ukraine.

Like Société Générale, RBI also has a large Russian subsidiary, which was the ninth-biggest bank by assets in Russia at the end of 2020, according to The Banker Database. But it is unclear whether RBI will attempt to sell its Russian subsidiary. In a statement on March 17, Johann Strobl, RBI’s chief executive, simply said the bank was “assessing all strategic options for the future” of the bank in Russia, “up to and including a carefully managed exit”.

Meanwhile UniCredit’s group chief executive, Andrea Orcel, has expressed his desire to exit Russia, while Citi has announced an intention to exit its consumer business in Russia.

As well as banks, other financial institutions, such as the major card network operators, have also distanced themselves from Russia.

Visa has said that all payments, including cross-border e-commerce transactions initiated with Visa cards issued in Russia, no longer work outside of the country, while Visa cards issued outside of Russia no longer work in the country.

Meanwhile, Mastercard has said that all its cards issued by Russian banks will no longer work, regardless of where they were used. Both Visa and Mastercard reported net revenues of around 4% from Russia in 2021.

Tim White, a sanctions specialist at AML RightSource, a financial crime compliance firm, says that this action by Visa and Mastercard is “a very significant move because you’ve got a significant population in Russia using these products — if they don’t work anymore, they will have to start writing cheques and dealing with a declining rouble”.

Revolut, the UK-based fintech, has also acted by no longer supporting transfers to or from Russia or Belarus, while its users will not be able to top up their accounts via cards issued by financial institutions in Russia or Belarus. 

Cyber risks

Jacob Gyntelberg, director of economic and risk analysis at the European Banking Authority, says that the immediate impact of the situation in Russia to European banks is minimal.

“The first-round effects, from our perspective, on the EU banking system are manageable,” he says. “The direct exposures on EU banks are quite small and it’s a limited number of banks that have most of the exposures.”

However, Mr Gyntelberg adds: “There is more uncertainty about the second-round effects and the medium- to long-term effects in terms of what is going to happen to inflation, monetary policy and how European governments will react.

“There are also concerns around what Russia is going to do to with energy supplies to Europe and cyber risks,” he says.

The main challenge will be how to keep sanctions effective over time

Tim White

The threat of cyber-attacks to financial institutions, and in particular via ransomware, have risen sharply since international sanctions were imposed on Russia, according to Sam Cousins, a sanctions and risk associate at the Association of Certified of Anti-Money Laundering Specialists (ACAMS).

In an end-2021 ACAMS survey, Russia was seen as the most likely origin point for a ransomware attack, with the financial sector seen most at risk for such attacks. This risk has risen after Russia was hit with sanctions, with the idea that Russia could use mass ransomware attacks as a way of generating revenue for its weakened economy.

“The main challenge will be how to keep sanctions effective over time,” says Mr White. “Advanced technologies like artificial intelligence must be applied to catch money laundering techniques that companies will use to skirt sanctions. We’re going to see a growth in the manpower to stop financial crime through technology.”

Limited options

In addition to international banks selling their Russian operations — whether to private buyers or the Russian state — the only other option for banks to exit Russia is to unwind their operations in the country. All options involve banks taking a financial hit. Société Générale, for example, said it will take a €3.1bn hit from the sale of Rosbank, comprising €2bn for the write-off of the net book value and divested activities, and €1.1bn for an exceptional non-cash item.

“In terms of de-risking in Russia, the options are quite limited,” says Ms Rudman. “Banks with large exposures will be taking hits and write-downs. The question might be if they can subsequently recover some of those losses.

“Banks have been reducing their exposure from 2014 onwards, which indicates that steps are being taken but it is difficult when you have a domestic presence in Russia. If you just have a loan book with Russian clients, the process to wind down your exposure is much simpler than if you are on the ground with operations in Russia.”

Mr Gyntelberg agrees that de-risking “is a big problem for European banks”.

“Many banks appear to have kept a siloed approach to their operations in Russia,” he explains. “But even if banks do not walk away, their assets still might be frozen by capital controls by Russia.”

Alexander Lehmann, a non-resident fellow at Bruegel, a Brussels-based think tank, says de-risking will go beyond Russia.

“This has made local exposures in high-risk emerging markets a different proposition,” says Mr Lehmann. “There is every reason now for banks to revisit their exposures in emerging markets, and I would expect subsidiaries to be up for sale over the next few years.”

He adds that he expects to see “further deleveraging and withdrawal from emerging markets by European banks due to financial, legal and compliance risks” over the coming years. “Clearly, any entity related to Russia will be subject to additional scrutiny,” he notes. “Banks will limit exposures on trade finance and cross-border exposures to countries in central Asia, like Kazakhstan and Azerbaijan.”

However, Sam Theodore, a senior consultant at Scope Group, disagrees that there will be a wider retreat by banks.

“This won’t lead to a shift in global bank strategies in emerging markets,” he says. “If anything, emerging markets will play a bigger role in the new world order created by the move away from Russia to other large producers of energy.”

Russian banks exit Europe

While European and international banks plot their exits from Russia, the country’s leading lenders are doing the reverse in exiting their operations in Europe.

In a statement on March 2, Sberbank said it had “taken the decision to withdraw from the European market” in response to its subsidiary banks facing “an exceptional outflow of funds and a number of safety concerns regarding its employees and offices”.

Meanwhile, VTB has been winding down its operations in Europe since early March and its UK arm was set to go into administration as The Banker went to press, in a sign of the severity of the international sanctions imposed on Russia, which has officially become the world’s most heavily sanctioned country.

“The sanctions are quite severe, and they have exceeded our initial expectations,” says Yaroslav Sovgyra, associate managing director for Europe, the Middle East and Africa banking at Moody’s.

Any impact on the asset quality and profitability of Russian banks is not possible to estimate accurately. It depends on when the sanctions will be lifted, which doesn’t look like anytime soon

Yaroslav Sovgyra

“There is a lot of uncertainty for Russian banks,” says Mr Sovgyra. “Any impact on the asset quality and profitability of Russian banks is not possible to estimate accurately. It depends on when the sanctions will be lifted, which doesn’t look like anytime soon.”

In March, Moody’s downgraded its outlooks on 39 Russian financial institutions to negative. “This is the biggest downgrade to Russian banks since the 1998 [Russian] financial crisis,” adds Mr Sovgyra.

“At this point, the word ‘unprecedented’ doesn’t even cover it,” says Mr White. “The fact that [Russian president Vladimir] Putin himself has spoken about the sanctions as an act of war says it’s working.

“We’ve seen sanctions in the past with the likes of Iran and Venezuela, but what makes these sanctions even stronger is the Western world uniting to support the folks of Ukraine under siege. The Western world has come together in support of democracy. The sanction regime is not against the people of Russia — they’re not in control of this but they will feel the pain.”

Mr Lehmann agrees about the strength of the sanctions. “The Russian banking sector has gone back 30 years in the space of a few weeks,” he says.

Swift ban

The list of sanctions on Russian banks includes the exclusion of Russian banks from the Swift financial messaging platform. However, many experts have questioned the effectiveness of this ban.

“The first thing to note is that [Swift] is a messaging and not a payment system,” says Angelo Ranaldo, professor of finance and systemic risk at the University of St Gallen in Switzerland. “It’s a way of dispatching messages among banks and not a way of operating payments. Yes, there are alternatives to Swift, such as China’s and Russia’s payment systems, so the exclusion of Russian banks from Swift is not an ‘atomic bomb’.”

However, Mr Ranaldo believes the exclusion from Swift is still effective for two reasons. “First, even if the settlement and credit risks remain, Swift is integrated in the core IT systems of banks, and so if you are disconnected from this, it makes payments more difficult and cumbersome,” he notes. 

“Secondly, we should remember that the Russian banking industry is highly concentrated, with as few as about five banks representing over 90% of the total market. So even though only a select number of Russian banks have been removed from Swift, it’s still an effective ban.”

Mr White agrees that the Swift ban is effective. “While Russian banks can find a way around this by using smaller banks who have not been excluded, it makes for a very awkward situation at the back office and raises a red flag for the recipient of the payment,” he says. “These payments will go under more scrutiny.”

As Russia’s invasion of Ukraine intensifies, there are ways to make the sanctions even more effective.

“First we can induce liquidity dry-ups that will result in insolvencies for Russian entities and individuals,” says Mr Ranaldo. “In addition to freezing the reserves of the Russian central bank, other sources of liquidity can also be targeted, such as cash and bank deposit accounts of people that have an influential role in the Russian economic-financial system. We can also target short-term funding, commercial credit and counterparties to make it difficult for Russia to issue financial securities such as bonds.”

However, Russia can circumvent the sanctions by passing through nations that are not aligned with the sanctions and through the use of cryptocurrencies, adds Mr Ranaldo.

“Russian can trade or issue fungible and non-fungible tokens,” he notes. “But at some point when it needs dollars, for example, it will need to come back to traditional finance and deal with mainstream banks and entities. There are also forms of centralisation in decentralised finance with systems such as Coinbase and Binance, or other blockchain platforms that could block the addresses of Russian users.”

If sanctions on Russia are made stricter, this will only accelerate the exit of international banks in the country.

“It’s difficult to justify the reasons for being in Moscow,” says Mr Theodore. “The rouble has collapsed and the economy is heading for a meltdown. The reason banks were in Russia in the past was because it was a very profitable and growing market. But it’s no longer profitable and growing so what’s the reason to be there now?” 

He believes that every foreign bank will stop writing new business in Russia and exit. “The alternative is to stay invested in Russia and be potentially blamed for indirectly funding war crimes,” he says. “As a Western bank in Russia, you have to hold domestic liquid assets, such as Russian sovereign bonds where at least some of the proceeds go towards funding the war and propaganda of the Russian government.” 


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