Russia’s invasion of the Ukraine saw the West unleash some of the most brutal sanctions ever against a country. By Justin Pugsley.
What is happening?
Clearly French finance minister Bruno Le Maire wasn’t bluffing when he declared: “We will cause the collapse of the Russian economy.”
In a rare show of unity, the West and its allies assembled some of the harshest sanctions ever imposed on a country — certainly the toughest for a G20 country.
The West has banned seven Russian banks from the Swift messaging system and, even more drastically, has frozen inter-central bank transactions. That leaves some 60% of Russia’s foreign exchange reserves stranded abroad.
The volley of sanctions triggered collapse of the rouble and of shares in Russian companies, and the Moscow Stock Exchange was promptly shut. The Russian central bank quickly relaxed some bank capital requirements so that they can support the economy. However, interest rates were jacked up from 9.5% to 20% to support the rouble, albeit in vain.
Being ousted from the global financial system will not hurt most Russian banks given they are mainly domestically focused.
What will hit them like a sledgehammer is soaring inflation and the economy diving into a deep recession. This implies a rush of loan defaults.
Why is it happening?
The West wants to send the strongest possible message to Russia that its invasion of Ukraine is completely unacceptable. The idea is to make it so painful that Russia reverses course, although there is no sign of that happening. If anything, president Vladimir Putin is doubling down on the invasion.
This is leading to even more sanctions, with the US banning Russian oil and gas imports and the UK planning to phase out Russian oil purchases by year end.
Russia, meanwhile, is thinking of cutting off gas supplies to Europe.
What do the bankers say?
Bankers are very worried. Some banks such as Société Générale, UniCredit, Raiffeisen Bank International and Citigroup have billions of dollars in the firing line. Fortunately, these exposures are small relative to their total exposures.
It is the exposures to Russian oligarchs who are now being sanctioned by the West that is worrying bankers most. They operate through a complex web of opaque corporate structures meaning that banks may accidentally still be servicing them. Another concern is that bank compliance departments simply cannot implement the rush of sanctions fast enough and could end up with huge fines.
To play it safe, many banks — including some Chinese ones — are now avoiding Russia completely, including non-sanctioned Russian banks and companies.
Will it provide the incentives?
Such is the rapid and drastic nature of the sanctions, it is unclear what the second order consequences might be. This is particularly the case if the war drags on, as seems likely.
For Russia, it means deep recession and possibly a banking crisis that the central bank may struggle to contain, given the parlous state of the rouble and its lack of access to much of its foreign reserves. Some analysts are now speculating that Russia could break apart, as some regions resent Moscow’s rule. This would cause huge instability across Eurasia.
Elsewhere, the war is rapidly sucking confidence out of the global economy; commodity prices are soaring and key supply chains are once again in disarray. Stagflation is now highly likely in the West.
If Mr Putin were to unleash tactical nuclear weapons in Ukraine, markets everywhere would go into instant free fall. For Mr Putin, that might be the ultimate financial revenge on the West, with little to lose as his own country is heading into dire straits.
And all this is happening as banks were trying to normalise their businesses following the Covid-19 pandemic, which itself involved extreme actions.
One possible consequence is that Russia and China could develop payment systems that completely bypass the current US centric ones. This is already happening on Sino-Russian oil deals. Another theory is that cryptocurrencies and their blockchains will emerge as true independent global payment alternatives.
Some analysts believe this could be a precursor to the US dollar being dethroned as the world’s reserve currency. That currently seems unlikely, but if it happened, it would be another chaotic convulsing moment for the global economy.
The stakes have probably not been this high since the 1962 Cuban missile crisis. Fortunately, cooler heads eventually prevailed and a third world war was averted. How the Ukraine crisis will end is impossible to tell, but it comes with some terrifying scenarios that stretch well beyond concerns over the health of the banking system.
