Banks Too Big to Sanction as War Wrecks Russia’s Ukraine Ties

Map of Ukraine, Including Crimea, and Neighbors, Including Russia

(Bloomberg – – Volodymyr Verbyany, Jake Rudnitsky – November 30, 2015)

Your enemy’s bank is your friend.

Or so Ukraine wants to believe after giving Russian banks a pass more than a year and a half into a separatist insurgency it blames on the Kremlin. Banks including state-run lenders sanctioned by the U.S. and the European Union have clung to their decade-long push into Ukraine, dodging the political acrimony that’s devastated business ties from airlines to energy.

“We treat all of them like Ukrainian banks,” National Bank of Ukraine Governor Valeriya Gontareva said in an interview. “There’s absolutely equal treatment and a level playing field for all banks in Ukraine.”

The links between banks in the two most populous ex-Soviet states have preserved what economic ties could be salvaged after Europe’s bloodiest conflict since the Balkan wars of the 1990s. Exiting the market would be costly for Russian lenders given the grim outlook for the economy and a lack of potential buyers. While the battlefields of eastern Ukraine have grown quieter since a truce negotiated in February, a rift with Russia still festers as the Kremlin considers a ban on Ukrainian food and threatens to push Ukraine into default.

Crisis Spillover

Following months of deposit outflows and a rout in the hryvnia, banking is essential if Ukraine’s battered economy continues to recover after exiting six quarters of recession. The crisis in Ukraine, which deepened after President Vladimir Putin’s annexation of Crimea in March 2014, quickly engulfed the country’s financial industry as the authorities imposed capital controls and the currency plummeted.

The share of overdue loans has more than doubled since the start of 2014 and was at 19.9 percent as of Oct. 1, central bank data show. Ukraine is liquidating 56 lenders, with eight declared insolvent. At least four, including Privatbank and AT Oschadbank, the country’s two largest, were forced to restructure debt.

As their competitors failed or retreated, Russia’s second-largest private lender, Alfa Bank OJSC, is looking to add to its Ukrainian assets by buying UniCredit SpA’s local subsidiary. Sberbank PJSC, VTB Bank PJSC and others are recapitalizing their units by $2 billion to avoid running afoul of the Ukrainian central bank’s requirements. Russian lenders have increased their share in Ukraine’s banking assets since the beginning of the crisis to 15 percent from 11 percent.

Record Losses

UniCredit’s planned sale shows why Russian lenders have little choice but to double down in Ukraine or write off a large portion of investments made since the mid-2000s. The Milan-based bank will probably have to record currency losses once the sale is completed, and it may have to inject capital and forgive loans to the Ukrainian unit before a possible deal, according to its first-half report published in August. VTB already had a 85.4 billion-ruble ($1.3 billion) loss on its Ukrainian operations last year.

“They have enough issues to address with the domestically owned banks without creating more headaches by going after the Russian banks,” Timothy Ash, a credit strategist at Nomura International Plc. in London, said by e-mail. “The overall investment is small change for Russia Inc. relative to the geopolitical leverage that this gives.”

Airlines, Energy

The economic relationship between Russia and Ukraine lies in ruins. Flights between the two countries were canceled on Oct. 25 following sanctions against Russian airlines imposed by Ukraine. Natural gas sales, a political lever the Kremlin has used against Ukraine in the past, were halted again in late November after a three-month disruption earlier this year. Russia is also threatening to stop coal deliveries to retaliate for the delay in restoring electricity supplies to Crimea.

Another dispute between the nations is a $15 billion debt restructuring Ukraine negotiated with private foreign creditors, which Russia has refused to join. Russian demands for repayments of a $3 billion bond coming due in December have been countered by a Ukrainian threat to default, with both sides saying they’re ready to take the fight to court.

Selective Sanctions

Most Russian companies operating in Ukraine have been forced to take sides. In October, Russia’s largest wireless carrier Mobile TeleSystems PJSC agreed to lease Vodafone Group Plc’s brand in Ukraine to hide its link with its home country. Lukoil PJSC, Russia’s second-largest oil producer, in April closed the sale of its retail and storage network in Ukraine, which included about 240 filling stations.

Russian banks also came under scrutiny not long after the separatist rebellion erupted, with Ukraine’s state security service opening a criminal case in April 2014 against officials at an unidentified Russian lender for financing terrorist activities. While Ukraine has sanctioned 24 Russian banks, it isn’t targeting lenders with significant holdings in Ukraine.

Untouched were Sberbank, Vnesheconombank, VTB and Alfa, whose units together make up 99 percent of Russian assets in the industry, according to Fitch Ratings analyst Olga Ignatieva.

Those banks “are quite important for the sector to be challenged,” she said. “The banking system — as well as Russian subs — have yet to emerge from the severe stress they’ve been through from the start of 2014.”

Hurting Yourself

If the biggest Russian banks appear immune to political posturing, that’s because sanctions against them would hurt Ukraine’s economy exponentially more than a ban on Russian flights transiting through Ukraine’s airspace, according to Ukrainian Infrastructure Minister Andriy Pyvovarskyi. Without their cooperation, vital parts of the Ukrainian economy could stall, he said, citing Sberbank’s efforts as one of the largest creditors to Ukrzaliznytsya to help restructure the rail monopoly’s debt of more than 30 billion hryvnia ($1.3 billion).

Even without a clampdown by authorities, the banks have taken a beating as Ukrainians lashed out at Russian-owned business across the country. In hryvnia terms, VTB lost 42 percent of retail deposits since the start of 2014, Sberbank is down 29 percent and Vnesheconombank’s Prominvestbank had a 6 percent drop. The country’s 10 other top lenders saw a net increase over the period, according to central bank data. Russian banks’ subsidiaries in Ukraine will require about $2 billion in recapitalization, Russian Finance Minister Anton Siluanov said in October.

Stress Tests

Ukraine’s central bank expects to complete stress tests of the country’s 20 largest lenders by mid-December to determine how much additional capital each bank requires, according to the regulator’s press office.

VTB, which has already spent 19.9 billion hryvnia to recapitalize its Ukrainian unit in 2014-2015, sees the momentum turning for Russian banks.

“At the start of the crisis, there was fear of Russian banks on the part of customers,” Konstantin Vaysman, the head of VTB’s Ukrainian unit, said in an interview. “Now they see us as we are: among the most solvent and reliable banks in Ukraine.”

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