Sanctions have sharply reduced the Central Bank of the Russian Federation's access to its foreign exchange reserves, increasing the risk that Russian banks will face a liquidity squeeze.
The central bank, or CBR, had $630 billion of reserves held across the world as of the end of January. Sanctions have been imposed on the central bank by the U.S., U.K., EU, Canada and Japan following Russia's invasion of Ukraine, and its access to foreign exchange reserves held in those jurisdictions is blocked.
"This has rendered a large part of these reserves inaccessible, undermining the CBR's ability to act as a lender of last resort and impairing what had been — until recently — Russia's standout credit strength: its net external liquidity position," said S&P Global Ratings in a recent report.
As a result, the central bank is less able to support the country's lenders with their own foreign exchange needs since the banks still have foreign exchange liabilities.
"As central banks' foreign exchange reserves are held predominantly in high-grade securities denominated in dollars and euros, restrictions on the transfer of securities make it nearly impossible to mobilize the reserves," said Ousmène Mandeng, visiting fellow in the School of Public Policy at the London School of Economics and Political Science.
Access denied
"[Russian banks] simply cannot borrow forex anymore, so if they have a liquidity mismatch they are close to failure," said Alistair Milne, professor of financial economics at the School of Business and Economics, Loughborough University.
Foreign banks had $121 billion of exposure to Russian counterparties as of September 2021, according to data from the Bank for International Settlements. Italy has the biggest exposure at $25.3 billion, followed by France with $25.1 billion, while Austria, with $17.5 billion, is also among the countries most exposed. The U.K. has just over $3 billion of exposure, while the U.S. has $14.6 billion.
Due to the sharp depreciation of the ruble, which has lost more than 35% of its value against the dollar since the start of the year, foreign entities suffered a significant write-down of their ruble holdings even before sanctions were imposed, said Mandeng.
"If the sanctions are effective, foreign holders of Russian obligations, of which there may be Russian entities offshore too, can de facto no longer claim, use, receive debt service on or repatriate any of their holdings," said Mandeng.
The CBR has retained access to China, which accounted for 13.8% of its foreign exchange reserves as of June 2021. It also had $132 billion in gold stored in vaults within Russia.
Some foreign exchange is also still available to banks since Russia is still exporting oil, gas and coal, though the U.S. said on March 8 it would ban imports of Russian crude and oil products, coal and LNG. The U.K. said it will phase out Russian oil imports, though the European Union, which is more reliant on Russian energy, is not following suit for now.
Russia reacts
On March 6, the Russian finance ministry said it would service and pay sovereign bond debts "in a timely manner and in full." However, it also said that holders of Russian debt, including nonresidents, must receive interest payments in rubles and that payment depended on the sanctions of foreign states.
The CBR has begun imposing financial restrictions in the face of sanctions. It has told exporters to convert 80% of their revenue into rubles, thereby ensuring the central bank has access to more foreign exchange.
It is also limiting nonresidents' ability to withdraw capital and Russians' ability to take cash across the border, and has increased interest rates to 20% from 9.5%. The CBR has said Russian banks will not sell foreign currency to retail clients until September and introduced a $10,000 cap on cash withdrawals from retail accounts denominated in foreign currencies.
While the CBR would like to close down unofficial trading of the ruble, such measures may not prove wholly effective, said Milne. "Then there will be a black market with a very much lower exchange rate for those desperate to get money out," said Milne.
Ratings woes
The capital controls imposed by the Russian authorities raise significant questions over the Russian state's willingness to service its debt owed to foreign residents, increasing risk and uncertainty over the direction of financial policy, according to rating agency Scope Group.
"They will hold further adverse implications for financial stability, making Russia more vulnerable to banking and liquidity crises, as well as significantly raising the risk of further negative credit rating actions for the Russian sovereign near term," said a spokesperson for Scope via email.
Fitch Ratings said March 9 that it regarded a default by Russia on its sovereign debt as "imminent." S&P Global Ratings has lowered its long-term foreign- and local-currency sovereign credit ratings on Russia to CCC- from BB+ and BBB-, respectively, and kept them on CreditWatch with negative implications.
"Asset freezes on the Bank of Russia and on subsidiaries and branches of Russian banks are the one powerful sanctions tool applied so far," said Milne.