The Russian assault on Kyiv and other Ukrainian cities has heightened uncertainty in the global economy. To condemn Putin’s war, Western leaders announced restrictive economic measures targeting Russian financial institutions and individuals.
Sanctions include: removal of some Russian banks from the Swift messaging system for international payments; freezing the assets of Russian companies and oligarchs in Western countries; and prevent Russia’s central bank from using its $630bn (£473bn) in foreign exchange reserves to undermine sanctions.
In response to these measures, several rating agencies have either downgraded Russia’s credit rating to junk status or signaled that they may do so soon. In other words, they think the prospect of Russia defaulting on its debts is higher than before. According to a group of global banks, a default is “extremely likely”.
The threat to banks
With more than $100 billion of Russian debt in foreign banks, it raises questions about the risks for banks outside Russia – and the possibility that a default could trigger a 2008-style liquidity crisis, where banks panic about the creditworthiness of other banks and stop lending to each other.
European banks are the financial institutions most exposed to the new Russian sanctions, especially those in Austria, France and Italy. Bank figures for a default to trigger a 2008-style liquidity crisis, where banks panic about the solvency of other banks and stop lending to each other.
European banks are the financial institutions most exposed to the new Russian sanctions, especially those in Austria, France and Italy. Figures from the Bank for International Settlements (BIS) show French and Italian banks each have outstanding claims of around $25 billion on Russian debt, while Austrian banks had $17.5 billion.
Comparatively, US banks have reduced their exposure to the Russian economy since the Crimean sanctions in 2014. Nonetheless, Citigroup has exposure of US$10 billion, although this is a relatively small portion of US$2.3 trillion in assets held by the bank.
There is also the question of exposure to a possible default by Ukraine on its debts. Ukraine’s bond debt of about $60 billion has also been downgraded to junk status, taking the risk of default from low probability to real danger.
In addition to debt exposure, many banks are going to be affected because they offer banking services in Ukraine or Russia. According to the rating agency Fitch, French banks BNP Paribas and Crédit Agricole have the most exposure to Ukraine due to their local subsidiaries in the country. Société Générale and UniCredit are the most active European banks in Russia, and both are also among the most exposed to Russian debt.
In other bad news for European banks, there has been a sharp increase in the cost of raising US dollar funds in the euro swap market. Banks use this market to raise the dollars that are essential to most international trade, so higher rates will put additional pressure on their margins.
So how serious are the overall risks of bank failure? The American investment research firm Morning Star estimates that the exposure of European banks, and even less of American banks, to Russia is ultimately “insignificant” in terms of their solvency. However, banks are also likely to be affected in other ways. For example, Switzerland, Cyprus and the United Kingdom are the main destinations for Russian oligarchs looking to store their money abroad. Cyprus also attracts Russian wealth with golden passports. Financial institutions in these countries are all at risk of losing business because of the sanctions. For example, the share prices of British banks Lloyds and NatWest have fallen more than 10% since the start of the invasion.
Beyond the banks
Besides the banks, the war will cause substantial losses for many companies with interests in Russia. Any companies that Russian companies owe money will struggle to get reimbursed, given that the ruble has fallen by 30% and the Swift restrictions will make payments very difficult. For example, Reuters reported that US companies have approximately $15 billion in exposure to Russia. Many of these debts will potentially end up being written off.
Some oil companies like Shell and BP have said they will get rid of assets they hold in Russia. Others, such as trading and mining group Glencore, which has large stakes in two Russia-linked companies, Rosneft and En+ Group, said they had them under scrutiny. But if the value of these assets evaporates because there are no buyers at reasonable prices, companies like these could face substantial write-downs.
A danger is that this will lead to a panic selling of the shares of these companies which creates a domino effect in the market similar to what happened with the banks in 2007-08.
Pension funds are also in the line of fire. For example, the Universities Superannuation Scheme (USS) team wants to sell its Russian assets. The USS is the UK’s largest independent pension scheme with around 500,000 customers and £90bn in funds. His Russian assets are worth more than £450m. The fall in value of these toxic assets is potentially going to be a bad blow. More generally, many investment funds also have money in Russian sovereign debt and also in shares of Russian companies. They too are looking at potentially serious losses.
In short, the ripple effects of this war are potentially huge, and many more are likely to emerge in the days and weeks to come. While the global economy is still recovering from the pandemic and is already dealing with significant inflation, markets have been very volatile. Russia’s invasion of Ukraine has intensified this situation, and finance will be on high alert to see how things unfold.
Also read: Russian President Putin warns third parties against creating a no-fly zone over Ukraine
Read also: Ukraine crisis: Israeli Prime Minister Naftali Bennett meets Putin in Moscow