Insight & Analysis

European banks worst hit in Russian exodus; compliance and operation risk dominates

Published: Mar 2022

Ratings groups say four European banks are the worst hit in the Russian exodus. Although none are likely to fail, preventing money getting to sanctioned Russian clients is highly challenging for banks’ operations teams as compliance and operational risk come centre stage.

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Three weeks into Russia’s invasion of Ukraine, Western banks like JP Morgan Chase & Co and Goldman Sachs have joined the steady stream of multinationals winding down their Russian business. Elsewhere, Citi, which ratings agency S&P; Global says has the largest Russian exposure of any North American bank, is also mulling its future in the country where it has around 3,000 staff, many in consumer branches in a retail business it had up for sale before war broke out.

Western lenders’ hurried exit from Russia will bring a financial hit. International banks are owed more than US$121bn by Russian entities, according to the Bank for International Settlements. Much of their exposure comprises cross-border lending to large Russian companies and excluding Russia from the SWIFT banking network makes it harder for banks to collect interest payments on their loans. The fall in the rouble makes these loans less viable anyway. Assets left behind by Western companies may be seized, and the investment banking arms of some of the big banks could also suffer losses on their Russian investments.

But it could be so much worse. After the annexation of Crimea in 2014 and the sanctions that followed, many lenders reduced their exposure. Today, European banks hold the bulk of today’s exposure with around US$84bn linked to banks in France (Societe Generale) Italy (UniCredit) Austria (Raiffeisen Bank International) and Hungary (OTP Bank). US banks have a much smaller exposure to Russia and total Japanese banking exposures to Russia was only US$9bn in 2021, according to BIS data – about 0.2% of total assets.

The resilience of the European four to withstand the loss of their Russian business is robust, say credit agencies. They flag that the biggest challenge will come via the role the Russian and Ukraine operations of these banks have played in their group strategy and blend of earnings. S&P; argues that this could crimp revenues and lead to modest additional credit losses, on top of any losses on direct Russian exposures. War in Ukraine is “fundamentally an earnings, and not capital or liquidity, story,” it says.

European banks’ losses should be cushioned by their large pre-impairment profits. Some of the exposure will also benefit from collateral or export credit guarantees, says FitchRatings. “The capitalisation of banks with Russian subsidiaries will also be affected by the depreciation of the rouble. However, we expect that most of the banks largely hedge the foreign-currency risk to avoid large swings in consolidated capital ratios.”

“Russia is important in terms of energy markets, in terms of commodity prices, but in terms of the exposure of the financial sector, of the European financial sector, Russia is not very relevant,” says Luis de Guindos, Vice President of the European Central Bank, addressing the risk to the banking sector. “The strains and the tensions that we have seen are not comparable at all to what happened at the beginning of the pandemic.”

But European banks exodus will bring pain points. Their departure will have profound consequences on the corporate clients they support with currency hedging, bond sales and managing global revenue streams. Since sanctions, these banks will have been working to support clients in-country, navigate sanctions and pay their suppliers and employees.

Preventing money getting into sanctioned Russian entities is highly challenging and time consuming for banks’ operations teams. Compliance and operational risk will now be centre stage for banks partnering with corporates that are the closely intertwined with Russia. France’s Societe Generale, which had almost US$21bn in exposure to Russia at the end of last year, recently said it is “rigorously complying with all applicable laws and regulations and is diligently implementing the measures necessary to strictly enforce international sanctions as soon as they are made public.”

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