There are four ways U.S. and European banks are exposed.
First, several still operate on the ground in Russia. It was a profitable market once and allied to their global ambitions. Many reversed course in the aftermath of the financial crisis as they reined in their global aspirations. Barclays Plc and HSBC Holdings Plc both exited Russian retail banking 10 years ago. But others are still there, among them Unicredit SpA, Société Générale SA, Raiffeisen Bank International AG and Citigroup Inc.
These banks function in Russia just like their local counterparts, raising deposits in rubles and making loans in rubles. They’re not subject to sanctions (which may give them a temporary competitive edge), but they are subject to the capital controls Russian authorities have put up in response, preventing them from repatriating earnings. Blocked from pulling out their capital, management is stuck. The increase in interest rates in Russia to 20% from 9.5% will squeeze bank margins and prompt higher credit delinquencies, leading to what could be heavy losses. Foreign banks will have to decide whether to throw good money after bad — recapitalizing them — or abandon them and write off the capital they have invested.
And that’s if the decision isn’t made for them: Russian authorities could seize the banks. Citigroup has been there before. In January 1917, it opened a branch in St. Petersburg (then known as Petrograd); within a year it had been expropriated by the Bolsheviks. “Value of this asset is extremely doubtful and should be charged off,” recorded federal examiners in 1920.
Raffeisen has the most exposure to this scenario. It acquired local lender Impexbank in 2006 (“a decisive step towards continuing our successful track record in Russia”) and became a top 10 Russian bank, with 2.4 billion euros ($2.6 billion) invested there. On an investor call last week, management reiterated its commitment to staying in Russia but laid out the worse case scenario to earnings if it were forced to walk away.
The second level of exposure comes via cross-border lending. Foreign banks had been reducing their loans to Russia since the Crimea invasion in 2014. At the end of September 2021, foreign banks had lent $121 billion into Russia, down from $269 billion in 2013. The trouble is that sanctions redefine what “exposure” actually means. Dutch bank ING Groep NA last week revised up its Russian exposure to 6.7 billion euros from 4.7 billion euros, after adding new elements such as “non-Russian borrowers with Russian ownership,” reflecting Western sanctions. Citigroup raised its disclosed exposure to $9.8 billion from $5.5 billion, adding at-risk items such as cash held at the Central Bank of Russia.
Again, banks have seen it before. In 1998, they suffered losses equivalent to about 60% of their non-sovereign loan exposure when Russia devalued its currency and defaulted on its domestic debt. Back then, Credit Suisse Group SA was hit especially hard and took writedowns and provisions of 1.86 billion Swiss francs ($2 billion at current rates), including marking its government securities at 10 cents on the dollar at the time.
While these exposures are very small relative to the size of the banks’ balance sheets – less than 1% in the cases of Citi and ING – the impact on earnings can be significant. In Citi’s case, writing off 60% of its exposure would knock pretax profits by nearly a third. Contrast that with less capital-intensive financial businesses like Visa Inc. and Mastercard Inc.; they have disclosed that 4% of net revenue is attributable to Russia, which is a much more contained exposure.
A third risk banks face is as enforcers of sanctions. It is their responsibility to ensure sanctions are complied with, and the penalties for facilitating breaches can be severe. In 2015, BNP Paribas SA was fined $8.9 billion for sanctions violations, the largest financial penalty ever imposed in the U.S. in a criminal case. Managing operational risks like these is as important – and potentially as costly – as managing a balance sheet. One reason sanctions have broadened beyond the parameters set by policy makers is that banks have been trained to be cautious of breaching them, even inadvertently.
Finally, there are the indirect effects, as with any macro shock. Research, unsurprisingly, suggests that geopolitical risk reduces bank stability. One popular measure of geopolitical risk puts the current climate back at levels not seen since the second Iraq war. The knock-on impact on trading activity, corporate confidence and other drivers of banks’ core business is as yet unknown.
Against these risks, banks have very high levels of liquidity and better solvency than they have had going into any crisis in decades. The 2008 playbook is a popular one to pull out at times of stress, but bank balance sheets are a lot stronger than they were then. Short-term, banks will suffer the collateral damage of financial warfare; longer-term, they will be fine, albeit perhaps with less appetite than ever to venture back into Russia.
More From Bloomberg Opinion:
• You Can’t Just Take a Russian Oligarch’s Townhouse: Chris Hughes
• Pariah Status Will Exact a Toll on Russia: Ashworth & Gilbert
• When War Hits, Even Crypto Can’t Stay Neutral: Lionel Laurent
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marc Rubinstein is a former hedge fund manager. He is the author of the weekly Net Interest newsletter on financial-sector themes.
