Is It Time to Start Worrying About European Banks’ Exposure to Russian Debt?

On a pound for pound basis, European banks are far more exposed to Russian debt than their U.S. counterparts. And Russia is looking increasingly likely to default on that debt. 

It is getting harder and harder for European banks to continue operating in Russia as the pressure rises on them to pack their bags. Or at least close the office doors until the dust settles from Russia’s invasion of Ukraine, assuming it ever does. Last Thursday (March 10), Deutsche Bank’s chief financial officer said it was impractical for the bank to shutter its Russian unit; a day later, presumably following some serious arm-twisting from European and US authorities, the bank changed its tune.

“Like some international peers and in line with our legal regulatory obligations, we are in the process of winding down our remaining business in Russia while we help our non-Russian multinational clients in reducing their operations,” wrote Dylan Riddle, a U.S.-based spokesperson for the German bank, in an email, adding “there won’t be any new business in Russia.”

First Movers

Goldman Sachs and JPMorgan Chase were the first major Western banks to announce they are leaving Russia following the country’s invasion of Ukraine. But the two lenders had already significantly pared back their operations in the country following Crimea’s referendum to join Russia in 2014. And whether or not the two Wall Street giants actually deliver on their threat remains to be seen. After all, both lenders have been gobbling up the distressed debt of Russian stocks and bonds after unprecedented economic sanctions crushed their market value.

The only major U.S. bank that has kept a large presence in Russia is Citigroup, which has around 3,000 employees in the country and close to $10 billion in total exposure. Citi said on Wednesday it was assessing its options.

On a pound-for-pound basis, European banks are far more exposed than their U.S. counterparts. As I noted in a previous article, cutting off Russian banks from the Belgium-based SWIFT payments system, the backbone of the cross-border payments and the global banking network, could backfire on European banks in a serious way. An unnamed banker cited by Reuters likened it to an “atomic bomb” for the industry since it could end up preventing the repayment of debts to European banks with significant exposure to Russia.

In the end, just seven out of 300 Russian financial institutions were cut off from SWIFT, but they included VTB, which has large operations in Europe. Even more importantly, the U.S., EU and Japan have barred the Russian central bank from accessing a large chunk of the vast foreign currency reserves Moscow had been amassing in their domestic banks. Russia’s central bank is still allowed to access its reserves for energy payments, which keeps a lifeline open for the central bank as well as for energy-dependent European countries. It is also still able to access the 13% of its foreign currency reserves held in Chinese yuan.

Looming Sovereign Debt Default

Nonetheless, this coordinated act by the US, EU and Japan to cut Russia off from its reserves has two huge potential ramifications: first, as NC has already covered in great depth (including in this piece by Michael Hudson), it risks doing serious damage to the U.S.’ dollar empire by essentially weaponizing the prevailing global currency system; second, it has made it much more likely that Russia will end up defaulting on its foreign debt, just as it did in its debt crisis of 1998/99 (albeit only on the foreign debt accrued during the Soviet-era). The International Monetary Fund Managing Director Kristalina Georgieva said on Sunday that a Russian sovereign debt default is no longer an “improbable event.”

Moscow has already threatened to pay international bondholders in roubles, which are sharply depreciating on an hourly basis, rather than dollars. On Monday, Moscow said it had sent an order to a correspondent bank to pay interest of $117.2m on external loans, which is due on Wednesday. Given many of its bond contracts do not allow for this, that in and of itself could be interpreted by ratings agencies as a default event. Last week, Fitch cut Russia’s sovereign debt even deeper into junk territory, warning that a default was imminent.

As the FT reports, Russia’s Finance Minister Anton Siluanov said on Sunday it was “absolutely fair” for Russia to make all of its sovereign debt payments in doubles until the West lifted its embargo of some $300 billion of the country’s reserves.

“We need to pay for critical imports. Food, medicine, a whole array of other vital goods,” Siluanov told a state television interviewer. “But the debts we need to pay to the countries that have been unfriendly to the Russian Federation and have limited our use of foreign currency reserves — we will pay off our debt to these countries in the rouble equivalent,” he said.

Siluanov said that almost half of Russia’s $643bn foreign reserves had been hit by the sanctions, but did not disclose the denominations and jurisdictions where Russia holds other currencies.

Investors have been bracing for a default, with both bonds trading at around 20 cents on the dollar. Moscow will have a 30-day grace period to make the coupon payments.

International investors hold around $170bn in Russian assets, according to Financial Times calculations, with foreign currency bonds accounting for $20bn. More than two dozen asset management companies have had to freeze funds with significant Russia exposure, while others have had to sharply write down their value.

Corporate bonds issued by Russian companies in USD, EUR, GBP, etc. are also facing default as the companies struggle to make interest payments to bondholders in foreign currency. The Russian government may even prevent them from doing so, forcing them to make the payments in rubles. Again, that could be construed as a default.

Ripples Through the System

The effects are rippling through the global financial system. The world’s largest asset management firm, BlackRock, has already posted $17 billion in losses on its funds exposed to Russian assets. JP Morgan Chase and Pimco have also posted large losses on funds they manage…

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