European banks are making heady profits in Russia

Days after Vladimir Putin’s invasion of Ukraine, Raiffeisen, an Austrian bank, said it was considering selling its business in Russia. Twenty-seven months later, the lender’s unit in the country is doing rather well. Its staff has grown to nearly 10,000, a 7% rise since 2022. Last year its profit reached €1.8bn ($2bn)—more than any of the bank’s other subsidiaries and a tripling since 2021. Raiffeisen is one of a dozen lenders that Russia deems “systemically” important to its economy. The bank also matters to the Kremlin’s own finances, since it paid the equivalent of half a billion dollars in tax 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 Russian operations have tripled, reaching nearly €3bn in 2023. Success makes the banks a target. In May America threatened to curb Raiffeisen’s access to its financial system because of the bank’s Russian dealings. On June 10th, in an attempt to placate critics, the lender plans to stop making dollar transfers out of the country. Russia, for its part, is starting to seize the assets of Western banks it deems “unfriendly”. Western lenders’ Russian paper profits are at risk of turning to ash.

Some European banks, such as France’s Société Générale, sold their Russian operations at the start of the war. Although those that remain have reduced their staff by just 3%, their portfolios have shrunk by quite a bit. Only Raiffeisen retains significant exposure, with 15% of its assets remaining in the country, compared with 5% for UniCredit, which has the next-most. But it, too, has slashed its loan book—by 58% since the invasion—and stopped making new loans (even if it is rolling over some existing ones).

What, therefore, explains the continued profitmaking? One answer lies in the spread between the meagre interest rates banks pay depositors and that of the Russian central bank. The latter stands at 16%, nearly four times as high as three years ago. Another answer is technical. In 2022, anticipating a rush of Russian defaults, banks booked hefty loan-loss provisions. When the feared tsunami of bad debt failed to arrive, these provisions were released, buoying profits, notes Halil Sentürk of Morningstar DBRS, a rating agency.

On top of this, sanctions have weeded out most Western competition. As a consequence, European diehards—in particular Raiffeisen—have benefited. After the invasion deposits at the Austrian lender soared, even though it kept its rates extremely low. That is because Russian depositors like to stash some of their cash in a Western bank, just in case domestic ones blow up. The lender also played a crucial role in helping foreign businesses move money in and out of Russia, accounting for nearly half of all payments with the rest of the world in February last year.

Yet such business is lucrative only on paper, since profits are tough to repatriate. Russia has stringent capital controls that prevent banks from shifting cash. At the same time, sizeable paper profits are attracting the attention of American and European regulators. Last month several lenders received a letter from the European Central Bank urging them to cut their exposure to Russia. Raiffeisen was ordered to slash its Russian loan book 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 facilitate transactions involving Russia’s military-industrial complex. In May Janet Yellen, America’s treasury secretary, warned European banks that “operating in Russia creates an awful lot of risk”.

The problem for European banks in Russia is that they have few exit routes. Ideally they would sell local units to other foreign companies, but few are interested in picking up such geopolitically complicated businesses. Selling to locals requires the approval of Mr Putin and, given the context, any deals are unlikely to be concluded at a fair price. Most recent attempts to complete sales have either dragged on or collapsed. More creative ways to repatriate capital involve big risks, too. Raiffeisen first came into the cross-hairs of America’s Treasury this spring, when it tried to swap some of its Russian assets for a stake in Strabag, an Austrian construction firm, ultimately owned by Oleg Deripaska, an oligarch under sanctions.

That leaves European banks with a final option: to continue winding down their Russian portfolios. But even this is far from straightforward, and not just because of the increased scrutiny from Western regulators. In May a Russian court ordered the seizure of the assets of Commerzbank and Deutsche Bank, two German lenders, because of their involvement in a gas project that was cancelled after the invasion. In a parallel lawsuit, the court also seized assets belonging to UniCredit, which is an Italian institution. All this means there is a good chance that many Western units in Russia will end up being at least partly written down. European banks face a high reputational price—and the pay-off is hardly likely to be worthwhile.

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