The U.S. decided to counteract Russia's invasion of Ukraine not with military might but a show of economic strength.
Since Russia entered the country on Feb. 24, 2022, there has been an almost unprecedented wave of sanctions against Russian banks, posing a major challenge for U.S. financial institutions that must now grapple with this new set of rules.
In February, the Treasury Department issued a
So far, Russia hasn't shown a willingness to back down, and there is the potential for conflict with other countries, such as China. All of that could create additional risk for American institutions.
"The main challenge is simply that there are far more sanctioned individuals and entities with a complexity of business arrangements that require the attention of banks' compliance departments," said Hera Smith, director of financial crime compliance at Moody's Analytics.
Doling out a punishment
After the start of the Russian invasion last year, Moody's GRID risk database, which measures global sanctions and compliance issues, reported that sanction risk events increased by 67.5%. That means there has been a huge increase in the number of risk factors that banks must analyze to ensure they're not doing business with a sanctioned entity, according to Smith.
"More sanctioned entities mean more risk profiles for banks to identify in order to cease engagement or freeze assets," Smith said, adding other complications come from an increase of evasive acts from sanctioned parties.
The U.S. has targeted more than 2,400 individuals and entities with its sanctions, covering 80% of Russia's banking industry by assets. That includes the country's 10 largest banks, such as Credit Bank of Moscow, the country's largest non-state owned bank. More than a dozen other banks are on the updated sanctions list from February, including MetallInvestbank, a Moscow-based financial institution that uses alternative methods to collect payments for Russian exports. Other sanctions include dozens of business people in Russia and Russian wealth management firms.
U.S. banks are barred from working with companies on the sanctioned list. That includes lending, storing funds and processing transactions. And U.S. businesses and consumers are banned from doing business with Russian financial institutions. Russian companies and banks have also been frozen out of the U.S. capital and bond markets.
In part to comply with the sanctions, hundreds of U.S. financial institutions,
The stakes are high for banks and other U.S. companies to ensure they are in compliance with the rules. Penalties include fines, enforcement actions and potential criminal prosecution and/or loss of licensing.
Avoiding running afoul of the rules is made even harder by the sanctioned entities, which at times try to work around the bans. For instance, one tactic is for a sanctioned institution to transfer ownership of assets to an associate that is not currently the subject of any actions. The sanctions extend to doing business with shell companies such as these. That makes it harder for a U.S. or Western bank to vet the actual owner of the assets, according to Smith.
"In the past, a simple list of sanctioned entities was enough to decode ownership structures and identify sanctioned parties, but with evolving strategies to help sanctioned entities avoid detection, new tools and strategies are necessary if compliance teams want to mitigate risk and adhere to sanction regimes," Smith said. "Due to the significant increase in workload, it is unachievable for the understaffed compliance departments to identify these changes, which is why we're seeing growth in automated risk monitoring in compliance."
Financial losses
The sanctions have had a major impact on Russia's economy, but not catastrophic thus far. Russia's gross domestic product sank between 2% and 4% in 2022, according to the World Bank and the International Monetary Fund. It's expected to decline another 3% and 6% in 2023.
For U.S. firms, there is the extra cost of compliance, including staff and monitoring. The war has also resulted in a boost in development of
Other effects of the sanctions on U.S. banks have been fairly muted. American banks had less than $15 billion in outstanding claims against Russian-based borrowers before the invasion, according to the International Monetary Fund.
"My general understanding is that Russia's banking system has stayed afloat but there are significant questions about its solvency," said Brian O'Toole, a nonresident fellow at the Atlantic Council, a think tank focused on foreign affairs.
Russia has been able to blunt severe outcomes, such as a run on bank accounts, by using harsh capital controls, O'Toole said. "Some of these controls have been lifted, but the banking system is quite weak."
Russia is being "pushed backwards," said Elina Ribakova, deputy chief economist at the Institute of International Finance, a trade group for the global financial services sector. "And any technology or other aid China could give Russia won't easily replace what Russia has lost by being tied to European and American financial services and other industries," she said.
Workarounds, such as a digital Russian currency or using cryptocurrency, a favored haven for autocratic regimes such as North Korea and Venezuela, won't make a big difference for Russia, according to O'Toole, who added Russia, like any country, needs access to mainstream banking to maintain a healthy economy.
"It does not seem like any of the more exotic methods of sanctions evasion have been used to a significant degree in Russia to replace lost access to Western banking networks," O'Toole said. "There may be some sanctions evasion via those methods but they cannot replace access to clear U.S. dollars for Russia's major banks."
Russia's war in Ukraine has raised concerns about the potential for tensions elsewhere, specifically that China might aid Russian President Vladmir Putin or could make a move against Taiwan. China has long claimed that Taiwan is part of its territory, though the country is currently independently governed.
Regarding China, there are a great many banks, in Hong Kong in particular, where security for personnel could be a flashpoint, but there would likely be some time before the safety of bank staff became a real issue. "This doesn't feel as imminent at the moment as increased violence by Moscow," O'Toole said.
There are also tradeoffs of using banking sanctions as a tool against adversaries, according to Eric Grover, a principal at Intrepid Ventures, a corporate development and strategy firm.
"Financial sanctions can inflict pain and make us feel good about ourselves, but rarely in and of themselves achieve desired policy outcomes," said Grover, who added that Putin wasn't likely to be swayed because Russian banks were cut off from SWIFT.
"Additionally, frequent use of financial sanctions by the U.S. encourages other countries to not be as reliant on U.S.-domiciled payment systems," Grover said.
