How Russian Banks Survive Under Sanctions

Leading Russian banks that are closely associated with the Kremlin have been under western sanctions for over a year.

Recent news on what methods VTB bank, the second most strategically important bank for Moscow after Sberbank, employs to circumvent sanctions and keep afloat is telling of the whole array of sanctioned state-affiliated banks in Russia. Instead of structural reforms, VTB has persisted with its inefficient dependency on Russian budget injections and zero change at the top, while cutting lower level staff and select projects and relying on home-grown propaganda and foreign lobbyists abroad.

In October last year Chief Executive Andrey Kostin insisted that most U.S. financial institutions maintained good working relations with VTB Group despite being blacklisted by the U.S. government over Russian actions in Ukraine. However, this supposed Wall Street empathy has not helped VTB from plunging into deep mess in 2015. By January Kostin was threatening that Russia’s removal from SWIFT would lead to break in diplomatic relations with the U.S. and by March he argued that U.S. sanctions against Russia undermine global financial architecture.

However, in reality sanctions were only undermining Putin’s ability to finance war while VTB saw its profits plummeting without access to western credit system. By end of June VTB boasted that it is not going to change its dividend system much but most market analysts, according to Kommersant, suggested to sell VTB’s stock. VTB’s loss for first half a year was over $250 million (17.1 billion rubles).

This loss would have been bigger if Russian state did not stop injecting money into regime-friendly bank. By end of July VTB completed the placement of around 307 billion rubles ($5.15 billion) of preference shares with the state corporation Deposit Insurance Agency. "The capital increase provides additional resources for VTB to catch up with the resumption of economic growth in Russia as well as to support import substitution programs and strategically important Russian industries and companies," Kostin said in a statement. In other words, no structural reforms were carried out. VTB simply continued serving Kremlin’s economic program if only on a more modest level.

Ex-KGB officer Kostin did not see his astronomical salary reduced ($37 million in 2014 according to Forbes) despite his previous claims that it is pegged to the bank’s profits. Nor did it change for other VTB top executives. Instead the bank had few waves of personnel cuts at lower and middle level (not more than 20%), sold stakes in some non-core assets, such as power generation firms, and closed down select operations abroad, such as equity trading unit in Dubai. However, boost at the expense of Russian state and “administrative support” (euphemism meaning privileged treatment from government bodies) remain at the cornerstone of VTB’s strategy for the foreseeable future.

One subtle way in which Russia finds ways to circumvent sanctions and carry on financing projects that sanctioned banks are not allowed to is through private banks loyal to the regime. Two weeks ago Reuters reported that four private banks with friendly ties with the Kremlin are emerging as big winners from Russia's economic crisis, helping out dollar-starved companies at a time when large state lenders are hampered by Western sanctions. In particular, one of the main beneficiaries is FC Otkritie, controlled by Oktritie Holding. The latter is co-owned by several bankers and industrial groups, all seen as loyal to the authorities but without particularly close ties with them. A 10% stake in Oktritie Holding belongs to VTB.

Another way to keep afloat with existing system, which VTB argues has nothing to do with circumventing sanctions regime, is to attract direct deposits from EU citizens through internet-banking. This is the scheme which VTB Direct, online-bank and a subsidiary of VTB in Europe, has used since late 2011. By the end of 2014 VTB attracted almost €4 billion (with €1,4 billion being attracted already under sanctions). VTB argues that this money is not used for VTB’s purposes and is serves the subsidiaries needs only. However, it did allow VTB Direct to pay out all debt that it owed to VTB before sanctions were enforced in 2014. Online banks of VTB and Sberbank in Europe remain outside sanctions regime.

Most complicated situation with VTB is in Ukraine. At the time when his bank was sinking in losses, in March 2015 Kostin called Ukraine a bankrupt country. Poroshenko’s government did not go bankrupt, however, its policy towards branches of Russian banks in Ukraine remained cautious. In spring and summer 2014, members of Rada urged the government to investigate activity of Kremlin-connected banks in the country and cut their ability to undermine Ukraine’s economy. These concerns were raised against subsidiaries of Sberbank, VTB, VEB, Alfa-Bank and other entities. However, so far only Prominvestbank, subsidiary of VEB, became blacklisted by the U.S. in Ukraine. National Bank of Ukraine (NBU) received a legal right to sanction this bank but decided not to do so.

There are many deposits of ordinary Ukrainians in Russian banks in Kiev, while their credit lines have penetrated the economy heavily. It is highly damaging to disentangle these links at once. In fact NBU had assisted Russian banks to keep afloat and has not hindered their de-capitalization programs from Moscow head banks. Despite having made losses in Russia, at the end of August VTB decided to boost its Ukrainian subsidiary by $680 million de-capitalization. However, Ukrainian authorities remain highly wary of VTB’s and other Russian banks’ intentions and monitor closely their activity in the country. Recently, Alfa-Bank decided to expand in Ukraine by absorbing UniCredit bank but it remains unclear whether it will get permission from the authorities for this move.

Most interestingly, despite all anti-U.S. rhetoric in early August VTB hired some of the most prominent lobbyists in Washington D.C., Manatos &Manatos, Greek Orthodox brothers with deep outreach in the U.S. Congress. While many commentators suggested that their task will be to mitigate or remove influence of sanctions on VTB’s global operations, it seems to be unrealistic. After all previous attempts by energy companies have not succeeded in that task.

Instead, VTB may be hoping to lobby that operations currently not prohibited under western sanctions stay that way, like above mentioned use of private banks or internet-banking in Europe. In addition this lobbying activity may have a particular target in sight.

At the height of Grexit crisis in June, Kostin unexpectedly said that VTB is interested to participate in the privatization process of Greece’s state assets. Industry sources also noted that VTB could act as a possible co-owner of newly built gas pipelines in Europe. It was at that time when Putin tried to push through Turkish pipeline, a project aiming to completely by-pass gas transit system of Ukraine through Turkey and Greece. Given that EU regulation, known as Third Energy package, prohibits Gazprom from owning both the supply and import pipelines in Greece, it is evident that one of the main services VTB could provide to the monopoly is to get its hands on gas assets in Greece and help to circumvent Third Energy package through possible ownership of the Turkish Stream in Greece.

Luckily for Ukraine and Europe, Kremlin has not yet agreed with Ankara even about one line of Turkish Stream going into the country. However, experience of VTB Bank under sanctions should serve as an important lesson of how superficial western sanctions are, and how, given abundant state support, Kremlin-connected banks like VTB can survive and continue their operations in Ukraine, Europe and elsewhere.

Ilya Zaslavskiy, energy and political risks consultant, specially for charter97.org