European banks make huge profits in Russia

Days after Vladimir Putin invaded Ukraine, Austrian bank Raiffeisen said it was considering selling its business in Russia. Twenty-seven months later, the lender’s unit in the country is doing pretty well. Its staff has grown to nearly 10,000 people, up 7% from 2022. Last year, its profit hit 1.8 billion euros ($2 billion), more than any of the bank’s other subsidiaries and three times as much from 2021. Raiffeisen is one of a dozen lenders that Russia considers “systemically” important to its economy. The bank is also important to the Kremlin’s own finances, having paid the equivalent of $500 million in taxes last year.

Raiffeisen is the biggest Western bank in Russia, but not the only one. The combined profits of the five EU banks with the largest operations in Russia have tripled, reaching almost €3 billion by 2023. Success makes the banks a target. In May, the US threatened to limit Raiffeisen’s access to its financial system because of the bank’s operations with Russia. On June 10, in an attempt to placate critics, the lender plans to stop transferring dollars out of the country. Russia, for its part, is starting to seize the assets of Western banks it considers “hostile.” The paper profits of Western lenders risk being turned to ashes.

Some European banks, such as France’s Société Générale, sold off their Russian operations at the start of the war. Although those that remain have reduced their staff by just 3%, their portfolios have shrunk considerably. Only Raiffeisen retains significant exposure, with 15% of its assets in the country, compared with 5% for UniCredit, which is next on the list. But it has also reduced its loan portfolio (by 58% since the invasion) and has stopped making new loans (although it is renewing some existing ones).

So what explains the continued profits? One answer lies in the spread between the meager interest rates banks pay depositors and the Russian central bank’s rate, which stands at 16%, almost four times higher than three years ago. Another answer is technical. In 2022, anticipating a wave of Russian defaults, banks booked large provisions for loan losses. When the feared tsunami of bad debts did not arrive, those provisions were released, boosting profits, notes Halil Sentürk of Morningstar DBRS, a rating agency.

Moreover, the sanctions have eliminated most Western competitors, which has benefited the more stalwart Europeans, particularly Raiffeisen. After the invasion, deposits at the Austrian bank soared, even though it kept its rates extremely low. That’s because Russian depositors like to keep some of their cash in a Western bank, just in case the domestic ones blow up. The bank also played a crucial role in helping foreign companies move money in and out of Russia, accounting for almost half of all payments with the rest of the world in February last year.

However, this type of business is only lucrative on paper, as profits are difficult to repatriate. Russia has strict capital controls that prevent banks from transferring cash. At the same time, the hefty paper profits are attracting the attention of US and European regulators. Last month, several lenders received a letter from the European Central Bank urging them to reduce their exposure to Russia. Raiffeisen was ordered to reduce its Russian loan portfolio by a further 65% by 2026, faster than the bank had planned. In December, the White House issued an executive order exposing foreign banks to secondary sanctions if they were found to be facilitating transactions involving the Russian military-industrial complex. In May, Janet Yellen, the US Treasury Secretary, warned European banks that “operating in Russia creates enormous risk.”

The problem for European banks in Russia is that they have few avenues for exit. Ideally, they would sell local units to other foreign companies, but few are interested in taking on such geopolitically complicated businesses. Selling to local companies requires Putin’s approval, and given the context, any deal is unlikely to close at a fair price. More recent attempts to complete sales have been protracted or failed. More creative ways of repatriating capital also involve big risks. Raiffeisen first came into the U.S. Treasury’s crosshairs this spring, when it tried to swap some of its Russian assets for a stake in Strabag, an Austrian construction company ultimately owned by Oleg Deripaska, an oligarch under sanctions.

That leaves European banks with one last option: further shrinking their Russian portfolios. But even this is far from straightforward, and not just because of increased scrutiny from Western regulators. In May, a Russian court ordered the seizure of assets from Commerzbank and Deutsche Bank, two German lenders, because of their involvement in a gas project that was cancelled after the invasion. In a parallel suit, the court also seized assets belonging to UniCredit, which is an Italian institution. All of this means that there is a good chance that many Western units in Russia will end up being at least partly written off. European banks face a high price in terms of their reputation, and the payoff is unlikely to be worth it.

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