Harsher sanctions against Russia could hurt U.S. banks

WASHINGTON — The nation’s banks are bracing for a prolonged period of economic instability and elevated compliance risk stemming from the Russian invasion of Ukraine, with anti-money-laundering policy, rising energy costs and cybersecurity emerging as top concerns in the weeks ahead.

The United States and a growing number of Western allies have unleashed unprecedented economic sanctions against the Russian Federation in the days since President Vladimir Putin announced a “special military operation” into Ukraine last week.

Already, those sanctions have targeted huge swaths of the Russian financial system, including the country’s central bank, its sovereign wealth fund and several of the nation’s largest private financial institutions. The impact has been dramatic, with the value of the Russian currency falling to historic lows this week — an act of economic warfare never directed at a world power in modern history.

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And while most American banks report having little direct exposure to the Russian economy, many more U.S. depository institutions will be on the front lines of the West’s economic response as they attempt to comply with a rapidly evolving sanctions regime.

Analysts say the emerging sanctions will be unusually difficult to comply with in part because of its exemptions — the U.S. is currently allowing for some Russian financial institutions to continue to facilitate energy payments to Europe, given the continent’s significant reliance on Russian natural gas.

“Banks are likely to focus on figuring out how to implement that, particularly because it's moving so quickly,” said Benjamin W. Hutten, counsel at Buckley LLP. “It's just not as easy as an on-off switch, which is how sanctions normally work.”

Western policymakers, led by the U.S., have also moved to cut off several key Russian banks from Swift, a global messaging system used by banks to help facilitate international payments. Again, the ban includes exemptions for energy transactions that U.S. banks will need to navigate.

But even with numerous carve-outs, energy markets have been roiled by the invasion, with the price of crude oil cresting $100 for the first time since 2014.

Elevated energy prices could contribute to broader economic pain in the U.S. down the road, analysts say, particularly if policymakers change course and target the Russian energy sector.

Removing the sanctions exemption for energy firms would “have incalculable effects on all kinds of things,” said Nicolas Véron, a senior fellow at the Peterson Institute for International Economics, who said that removing those energy exemptions is one of the biggest remaining levers available to policymakers to ramp up pressure on Russia, but one that would have a significant impact on U.S. banks.

“You could just think of it as oil price,” Véron said. “If that goes through the roof, for the U.S., the good news is that it’s not a big net importer of hydrocarbons, so there’s bad news at the gas pump, but good news for some companies.”

But “sharp increases in oil prices is not good for the U.S. economy, by and large,” Véron cautioned.

President Biden acknowledged in a speech last week that sanctions against Russia would have detrimental effects on fuel prices and would proactively try to limit those effects. But the sanctions are critical to rebuffing Russia's incursion into a foreign country, he said.

"I will do everything in my power to limit the pain the American people are feeling at the gas pump. This is critical to me," Biden said. "But this aggression cannot go unanswered. If it did, the consequences for America would be much worse. America stands up to bullies. We stand up for freedom. This is who we are."

It remains to be seen if, when and how the U.S. and its allies will escalate its economic response to the crisis. Russia’s assault has reportedly been bogged down by operational difficulties and a robust defense mounted by Ukranians, but Putin has shown no sign of backing down.

If the U.S. determines additional sanctions are necessary, bankers may anticipate an approach closer to the one taken under the Obama administration in response to Iranian nuclear development in the mid 2010s. That could mean a broader, even complete crackdown on Russian bank access to Swift — though the consequences of such a move for Europe could be severe.

“So far, only some Russian banks will be disconnected from Swift, but there could be a point where either more banks are individually targeted, or where we follow the approach taken with Iran, in which all of the banks in the country were kicked off of Swift,” Hutten said. “That would be a drastic measure and one that Europe could be hesitant to take because of how it would complicate payment for energy transactions.”

A complete block on Russian access to Swift could also jump-start international efforts to create an alternative to the system, potentially undercutting the role of the U.S. dollar in the global economy.

“The debate will be if fully cutting Russia off from Swift is worth the risk of broader adoption of either the Russian or Chinese alternatives,” said Jaret Seiberg, a policy analyst with the Cowen Washington Research Group, in a research note on Tuesday. “Multiple systems are less efficient, but if there is enough adoption it could permit China and Russia to further reduce reliance on the U.S. dollar.”

Another escalation applied during the Obama years against Iran could be the adoption of “secondary sanctions,” where rather than simply targeting or blocking specific institutions from the U.S. financial system, authorities would also target any individuals or businesses still involved with the sanctioned actors.

With secondary sanctions, “any entity providing material support or conducting material business with the already sanctioned institutions or people would face the threat of being subject to sanctions themselves,” Hutten said. “Secondary sanctions were widely credited with bringing Iran to the negotiating table.”

Some Republican lawmakers in Congress are already calling for the application of secondary sanctions. Sen. Pat Toomey, R-Pa. and ranking member on the Senate Banking Committee, called for “harsh sanctions on Russia to ensure Putin understands there will be a crippling cost to his abuses” in a press release last week. Toomey, along with Sen. James Risch, R-Ida. and two dozen Senate Republicans, introduced the Never Yielding Europe's Territory Act last week, which among other things would “make Putin feel the consequences of his invasion of Ukraine by imposing secondary sanctions on Russian financial institutions.”

Still, the sanctions already in place are expected to do a historic amount of damage to the Russian economy in the weeks and months ahead. Some analysts say that American banks must prepare now for the possibility that Russia will retaliate by targeting U.S. financial institutions as its domestic conditions worsen — particularly through cyber warfare.

Rene Perez, financial crimes consultant at Jack Henry & Associates, said that if any U.S. banks have specific security policies in place for periods of escalated cybersecurity risks, “now is one of those times.”

“Russia has already attacked Ukraine’s financial institutions — they’ve actually wiped out several institutions’ data,” Perez said. “It’s only a matter of time, as our sanctions start to squeeze Russia, that their cyber operations are going to redirect to other countries.”

Perez also noted that beyond U.S. sanctions, banks should also prepare for a significant uptick in fraud, particularly if the Russian economy enters a prolonged economic recession.

“Even if we get out of this cleanly, where Russia backs out of the country, sanctions start lessening — we're gonna leave their economy pretty hurt,” Perez said. “Just like any kind of recession that we go through in the United States, fraud intensifies [during and after recessions]. So we're gonna see a big burst of that after all this is done.”