US takes aim at Chinese banks aiding Russia war effort

U.S. Secretary of State Antony Blinken, center, in Capri, Italy, for a Group of Seven meeting last week. PHOTO: CLAUDIA GRECO/REUTERS
U.S. Secretary of State Antony Blinken, center, in Capri, Italy, for a Group of Seven meeting last week. PHOTO: CLAUDIA GRECO/REUTERS

Summary

Washington says Beijing’s dual-use trade has helped Moscow rebuild its war machine.

The U.S. is drafting sanctions that threaten to cut some Chinese banks off from the global financial system, arming Washington’s top envoy with diplomatic leverage that officials hope will stop Beijing’s commercial support of Russia’s military production, according to people familiar with the matter.

But as Secretary of State Antony Blinken heads to Beijing on Tuesday, the question is whether even the threat of the U.S. using one of its most potent tools of financial coercion can put a dent in complex and burgeoning trade between Beijing and Moscow that has allowed the Kremlin to rebuild a military badly mauled by more than two years of fighting in Ukraine.

China has heeded Western warnings not to send arms to Russia since the beginning of the war, but since Blinken’s trip to Beijing last year, China’s exports of commercial goods that also have military uses have surged. With China now the primary supplier of circuitry, aircraft parts, machines and machine tools, U.S. officials say Beijing’s aid has allowed Moscow to rebuild its military industrial capacity.

The West now worries Russia could win against Ukraine in a war of attrition, particularly if allies don’t mobilize their own industries to match Russian production.

Blinken and other top cabinet officials have been sounding the alarm among Western allies, including last week at a meeting of the Group of Seven industrialized nations in Capri, Italy.

But this time as he heads to China, officials are counting on the threat of Chinese banks losing access to the dollar and the risk of roiling trade ties with Europe persuading Beijing to change tack. The banks serve as key intermediaries for the commercial exports to Russia, handling payments and providing client companies credit for trade transactions.

“China can’t have it both ways," Blinken said in Capri. “It can’t purport to want to have positive friendly relations with countries in Europe, and at the same time be fueling the biggest threat to European security since the end of the Cold War."

U.S. officials say targeting banks with sanctions is an escalatory option in case the diplomatic overtures fail to persuade Beijing to curb its exports. U.S. officials have ramped up pressure on Beijing in recent weeks in private meetings and calls, warning that Washington is ready to take action against Chinese financial institutions handling trade in such dual-use goods.

“Any banks that facilitate significant transactions that channel military or dual-use goods to Russia’s defense industrial base expose themselves to the risk of U.S. sanctions," said Treasury Secretary Janet Yellen earlier this month amid meetings with counterparts in Beijing.

Officials say they hope the combined Western diplomatic pressure will avert the need to take an action that could break a fragile detente between the two powers. Cutting banks off from access to the dollar—the denomination of most of global trade—has much broader implications than normal sanctions targeting individuals and firms, and so are often reserved as a last resort. Such sanctions often force banks into failure, affecting their entire customer and client base, and represent a particular risk for China as the country grapples with growing credit problems.

In the past, however, the mere threat to target banks have had short-lived results. In December, President Biden signed an executive order that gave the Treasury Department authority to sanction banks that aid Russia’s military-industrial complex.

That created bottlenecks in China-Russia trade transactions as major Chinese banks backed out of any roles in facilitating the deals, said Alexandra Prokopenko, a fellow at the Carnegie Russia Eurasia Center think tank and a former employee of Russia’s central bank.

But, she said, those banks have gradually been replaced by more obscure regional Chinese banks with little work in the dollar-denominated economy, and hence less to fear from U.S. sanctions. “Payment chains are slowly being rebuilt," Prokopenko said. “Both Russians and Chinese are constantly adapting to the new conditions."

Trade in some of the most critical dual-use goods for Russia’s military surged after Xi’s meeting with Putin in March last year, according to a recent analysis published by the Center for Strategic and International Studies, a Washington-based think tank. CSIS said the number of shipments of key dual-use goods, including helicopter parts, navigational equipment and the machines used to craft precision parts for weapons and aircraft jumped from just a few thousand a month to nearly 30,000 a month.

“This has ultimately enabled the Kremlin to speed up its weapons production, including armor, artillery, missiles, and drones, and put up an effective defense against Ukraine’s 2023 counteroffensive," said Max Bergmann, a senior fellow at CSIS.

At the outset of the war, Xi appeared sensitive to calls from the West to refrain from shipping military equipment to Russia, but since then the Chinese have found workarounds. The Chinese don’t provide them with anything that looks like a weapon," said a senior European diplomat based in Washington. “The components we are talking about—chips, machinery, tools—these are components you put into a weapon."

Part of the challenge the U.S. faces is that the trade isn’t just a strategic investment for Putin, but also for Xi, the diplomat said. The two men, who have met dozens of times, spent years laying the groundwork for closer trade ties before the invasion of Ukraine, including by fostering more trade in ruble and yuan as a way to insulate their economies from Western sanctions, the official said.

“I don’t think Putin would have had the courage to start the war without understanding that the Chinese would support him technologically," the diplomat said.

The Chinese shipments to Russia have been critical to reassembling parts of the Russian military broken and destroyed by the first disastrous year of its invasion in 2022, say officials and analysts. The trade has also helped mitigate a labor shortage Western officials had hoped would cause the economy to buckle. But the Chinese supply lines will also be important to the resilience of Russia’s military production in the coming years as it launches offensives to take new Ukraine territory.

China’s foreign ministry calls the sanctions against its firms, including for dual-use shipments, “economic coercion, unilateralism and bullying."

“China will continue to do what is necessary to firmly safeguard the lawful rights and interests of Chinese companies," the ministry’s spokesman told reporters in a recent press conference.

Washington’s European allies have shown even more reticence to apply punitive measures against a major trade partner and financier, sanctioning only a fraction of the scores of firms put on U.S. rosters.

Olaf Scholz, chancellor of Germany, acknowledged China’s refusal to sell weapons to Russia during his meetings in Beijing last week. Germany and some other key European allies had been satisfied with that no-arms policy as enough.

“Now there’s an effort to adjust that in part because of the scale of Chinese support," a former senior U.S. national security official said. “The hope is that we get the Europeans to read China the riot act."

Scholz hinted at a change in policy after his meetings, though when pressed by reporters, he declined to elaborate. “The question of dual-use should not be ignored either," he said.

The U.S. believes that Europe’s financial and trade ties with China means it has more diplomatic sway than Washington over Beijing.

“There is underused leverage by the West, especially given the dollar and euro dominance in the financial system," said Maria Snegovaya, a senior fellow at CSIS and one of the chief authors of its recent report. “That could be one promising avenue to deal with the problem."

Lingling Wei contributed to this article.

Write to Ian Talley at Ian.Talley@wsj.com and Alan Cullison at alan.cullison@wsj.com

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