Russia’s banks turn from global ambitions to survival

In the run-up to Russia’s invasion of Crimea in 2014, VTB Bank, the country’s second-largest lender, dedicated an entire floor at its Imperia Tower headquarters in central Moscow to finance the country’s war machine.

Given the sensitive nature of the operation, foreigners were forbidden access to the floor, according to former employees of the bank. The ban even extended to the foreign executive supposedly overseeing the business unit.

“There was always a great deal of mystery about what went on in that department, but everyone knew it was funding a military-industrial complex,” said a former senior VTB executive whose lift pass denied him access to the floor.

In 2018, the Kremlin transferred defense lending to a smaller bank in an attempt to protect VTB – as well as the country’s biggest lender Sberbank, which also financed the military – from sanctions.

But Russian President Vladimir Putin’s full-scale invasion of Ukraine has meant that both VTB and Sberbank have now become targeted in a western campaign aimed at choking the country’s financial system.

Sanctions – which have frozen VTB’s assets and will kick the group off the global Swift payments system, while Sberbank has been blocked from using the dollar – have already started to bite. Sberbank has been forced to pull out of central and eastern Europe, and VTB is making plans to wind down its European operations.

German authorities are monitoring VTB’s Frankfurt operations closely, according to people familiar with the matter, aware that a disorderly departure could cost the country’s deposit insurance scheme billions of euros.

The two state-backed lenders had close to 1mn retail customers across Europe, while also managing accounts for local governments and hundreds of businesses. Their pullback from Europe, already under way before this year’s sanctions, marks the end of a two-decade strategy among Russian banks to expand internationally.

But it is at home, where the two lenders account for nearly half of the banking market, that sanctions will hit harder. Executives within both banks fear that spooked customers will rush to withdraw savings and worry that restrictions on dollar funding will mean that thousands of corporate customers could be deprived of hard currency.

People queue at a Sberbank branch in Moscow
People queue at a Sberbank branch in Moscow on February 25 © Vladimir Gerdo / TASS / Getty

Just two months ago, Sberbank was Europe’s second most valuable bank by market capitalization behind HSBC, while it remains the continent’s second-largest by number of customers, with 102mn compared to Santander’s 148mn. Last year it made a record $ 16.6bn of net income based on end-of-year exchange rates.

“There is no banking system in Russia without Sberbank,” said Ilan Stermer, director of research banks at Renaissance Capital.

Sberbank, which traces its roots back to a decree in 1841 from Emperor Nicholas I, was reorganized as a joint-stock company in 1991 following the collapse of the Soviet Union. The bank retained close ties with the Kremlin and throughout the 1990s was the only Russian bank to benefit from a government guarantee on deposits.

Its network of 17,000 green-liveried branches meant it was often the only lender available to rural communities across the vast hinterland.

Sberbank’s nationwide presence and security encouraged Russians to flock to open accounts in the 1990s, even though interest rates it offered sometimes struggled to keep up with the country’s rampant inflation. It also became the main bank for Russians to stash away retirement savings.

“It’s important not only because it keeps the bulk of household savings, but Sberbank is very often the only bank able to provide big lines of credit to big corporations because of its size and capital – no other bank can take the same risk,” he said. Sergey Aleksashenko, former deputy governor of the Russian central bank. “Sberbank being under sanctions creates big problems for Russian corporations getting credit.”

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In 2020, Russia’s central bank sold its 50 per cent plus one share stake in Sberbank to the country’s finance ministry as part of a broad plan to raise state revenues to pay for Putin’s promise to raise living standards.

The move also strengthened the finance ministry’s oversight of Sberbank and its powerful chief executive, Herman Gref, who has known Putin since the 1990s.

Gref had been widely praised for adopting western-style governance and technological change at Sberbank, which was seen as a corrupt dinosaur when he left the cabinet to take it over in 2007.

More recently, Gref has overseen a digital transformation, aiming to turn the lender into “Amazon’s”. Of the bank’s 102mn customers, 27mn use its banking app daily.

But Gref’s tech ambitions set him on a collision course with state officials, who wanted the bank to focus on paying dividends to fund Putin’s spending promises.

“For him, [sanctions are] a personal tragedy, ”said a former Sberbank director. “He has been running the bank for 15 years and achieved a lot, making it a tech leader and improving its profitability. Now what he has built will be pretty much destroyed. ”

“Sberbank has a big problem, but it will not die,” said Aleksashenko, the ex-central banker.

Herman Gref
Sberbank’s chief executive Herman Gref, pictured, has known Russian president Vladimir Putin since the 1990s © Chris J Ratcliffe / Bloomberg

While Sberbank has traditionally been Russia’s retail bank, VTB, which is 92 per cent owned by the government, has acted as the state’s investment banking arm. Launched in St Petersburg in 1990, VTB’s initial role was to finance Russia’s post-Soviet domestic economy and connect it to international markets.

“It was the rubbish bin for everything that didn’t work in corporate Russia,” said a person with close links to the bank. “The government relied on it to take over all these businesses, turn them around and return them to the market.”

VTB also developed a retail bank and in the early 2000s set about acquiring more in Europe, setting up investment banking operations in international financial centers and emerging markets.

Putin set out to build VTB into Russia’s answer to Deutsche Bank after Josef Ackermann, the German bank’s then chief executive, told the Russian leader in 2007 that his country would not be considered a “great nation” until it had a prestigious investment bank.

“VTB’s real job was to try to attract capital to Russia, help Russian companies raise money in international markets and help the government raise money for its sovereign bonds,” said a former VTB executive. “It was the pipe between Russia onshore and overseas.”

The global expansion has not been without controversy. VTB’s Mozambique business became embroiled in the country’s $ 2bn tuna bonds scandal, while the bank and its executives have been hit by a stream of sanctions since the annexation of Crimea.

VTB was once forced to apologize after its chief executive, Andrei Kostin, described Boris Johnson, who was UK foreign secretary at the time, as a “jerk”.

Kostin, who has been placed under EU and US sanctions, is a former diplomat with no formal banking training. His $ 56mn superyacht, Sea Rhapsody, is currently located in the Seychelles, according to yacht data company VesselsValue.

Kostin’s deputy, Denis Bortnikov, was added to the US sanctions list last month. Bortnikov’s father, Alexander, is the head of Russia’s FSB spy service.

The Russian central bank’s initial response to the tumbling ruble – doubling interest rates to 20 per cent – will cause longer-term pain for its banks because customers will be less inclined to borrow.

But bankers at Sberbank and VTB are confident that the central bank will step in to ease a liquidity crunch should customers rush to withdraw their savings.

The headquarters of Russia's central bank
Russia’s central bank doubled the key interest rate to 20% © Andrey Rudakov / Bloomberg

Bankers are also hopeful that the government will help prop up their plunging share prices. Sberbank’s Moscow-listed shares fell more than half in the days following Russia’s invasion of Ukraine and are expected to fall further when markets eventually reopen and western investors sell up.

The government “will interfere in the markets, they will buy up public equities and if bank capital comes under pressure, they will recapitalize them,” said the former Sberbank director. “But one thing they can’t do is keep the dollars flowing. Pretty soon that will be a major challenge. ”

Although Sberbank and VTB are listed in Moscow, they are also traded in London through global depositary receipts, which allow cross-border investment.

Sberbank’s London listing crashed from $ 15 to just $ 0.01 in the days leading up to the invasion. The London stock exchange has since suspended trading in both banks’ GDRs.

Neither bank responded to requests for comment.

As with Sberbank, VTB is too critical to Russia’s economy for the central bank to allow it to fail, Renaissance Capital’s Stermer said. But the sanctions will halt its global ambitions.

“If it can’t work with the west, it will have to refocus on the domestic side,” Stermer added. “Maybe it shifts its focus towards Asia, to the extent that its international trade is not completely cut off.”

During VTB’s global expansion in the 2000s, the bank chose a prominent City of London office at 14 Cornhill, just next to the Royal Exchange and Mansion House. The location enabled VTB to fly a huge Russian flag over the Bank of England, in a defiant gesture of financial expansion.

VTB’s London office peaked at more than 500 bankers, with executive staff coaching from rivals in an attempt to make the bank a big player in the City.

But having signed a 20-year lease in 2008 on the building that had once served as headquarters for Lloyds Bank, VTB has been subletting floors in recent years as staff have been let go or transferred to Frankfurt. Last month the LSE suspended its membership, effectively blocking it from trading on the market.

On Monday afternoon, the flagpoles jutting out from the top of 14 Cornhill were bare.

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