Beyond the human cost of the conflict, Russia's invasion of Ukraine has roiled financial markets and driven oil and other commodity prices higher. In combination with the fallout from the unprecedented sanctions imposed on Russian entities and capital controls in Russia and Ukraine, this has profoundly changed the operating environment for financial institutions operating in Russia, Ukraine, and Belarus. It also led to the failure of the European subsidiaries of PJSC Sberbank (see related research).

Outside these territories, financial institutions are grappling with implementing multiple sanctions and are actively managing risk to mitigate any fallout on their credit and market exposures. Four European banking groups have sizeable Russian and Ukrainian exposures, but we see this as more meaningful for some than others, and we anticipate that all will demonstrate resilience. After years of retrenchment from Russian exposures (since 2014) other international financial institutions now have modest direct exposures to the region, and in and of themselves these are highly unlikely to lead to rating actions.

Still, there is a high degree of uncertainty about the extent, outcome, and consequences of the conflict. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include sustained dislocation in commodities markets -- notably for oil and gas -- supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: Russia-Ukraine Macro, Market, & Credit Risks.

Financial institutions face heightened operational risks around their implementation of sanctions and cyber warfare, but more broadly there could be profound and protracted effects from changed macroeconomic prospects, credit conditions, and economic decoupling. Where it arises we see the impact as most likely to be credit-relevant for EMEA financial institutions, not least those active in economies that are the most closely intertwined with Russia. Note that the timing of publication for rating decisions on European issuers is subject to European regulatory requirements.

Widespread Negative Rating Actions On Financial Institutions in Russia, Belarus, And Ukraine

We have taken negative rating actions on financial institutions in Russia, Ukraine, and Belarus, many of them linked to rating actions on the sovereigns and our view of the deteriorated operating environment. Many of these institutions have been placed on CreditWatch, indicating the likelihood of further downgrades in the near term. (Note, however, that we have suspended our ratings for financial institutions included on the U.S. Department of the Treasury's Office of Foreign Asset Control (OFAC) sanction list.)

Russia's military conflict with Ukraine has prompted a new round of G7 government sanctions, including ones targeting the foreign exchange reserves of the Central Bank of Russia (CBR); this has rendered a large part of these reserves inaccessible, undermining the CBR's ability to act as a lender of last resort and we see an increasing risk of sovereign default in Russia (see related research). Intensified volatility in the domestic market and the local currency could in turn erode banks' profitability and capital positions. Similarly, Belarus might not escape the spillover effects of the increased pressure and volatility in Russia. We believe pressure on the Belarusian economy and banking sector stability will likely build. For Ukraine, the conflict has added significant downside risks to its economic outlook and the stability of its financial system, making it more challenging for commercial banks to honor their obligations in full and on time.

Exposure For Other Financial Institutions Is Highest In Europe

Four rated European banks have meaningful subsidiaries in Russia--the Raiffeisen Banking Group (RBG), OTP Bank (OTP), Societe Generale (SG), and UniCredit (UC). Of these, RBG and OTP also have a presence in Ukraine, and their combined Russian/Ukrainian credit exposures represent about 5% and 7% of total assets respectively. For SG and UC, the combined Russian/Ukrainian credit exposures are notable in absolute terms--for example €18.6 billion for SG--but account for a more negligible share of these banks' total assets and earnings (see chart 1).

Chart 1

To assess the potential direct hit to capital for these groups, we run a sensitivity analysis building on the results of the latest European Banking Authority (EBA) stress test, but also envisaging the possibility of a full write-off of the Russian/Ukrainian subsidiaries (see box). Our analysis suggests that these banks' resilience should generally be strong, certainly under our base case in which they experience a substantial pick up in credit losses, and even in the more extreme scenario where they lose their equity investments in local subsidiaries. We also note that the effects of higher credit losses over three years overstates the capital impact because we do not include the benefit to these groups of their earnings from other markets in this timeframe. Nevertheless, our analysis shows a greater impact on OTP. This is important for our ratings analysis because OTP has less headroom than the other banks in our capital analysis. (We typically look for a risk-adjusted capital [RAC] ratio of at least 7% to support our assessment that a bank's capitalization is adequate.) This greater rating sensitivity is the principal reason why we lowered OTP's stand-alone credit profile (SACP) by one notch, but we did not do so for RBG. Furthermore, our ratings on SG and UC were unaffected given their relatively low exposure to Russia and Ukraine. However, for all four groups, we keep in mind the role that their Russia and Ukraine operations have played in group strategy and their blend of earnings--in recent years these relatively higher risk higher reward operations often compensated for depressed earnings in some of their home markets.

Table 1

For Banks Outside EMEA, The Direct Ratings Implications Of The Conflict Are Limited

We see very limited ratings implications from the conflict in terms of first-round effects. Foreign banks' exposures to Russia reduced substantially following the 2014 sanctions in response to Russia's annexation of Crimea, and overall their exposures to Russia are small, both in monetary terms and as proportion of total assets (see chart 2). Globally, for banking systems in Bank for International Settlements (BIS) reporting countries, exposures to Russia as of September 2021 amounted to $104.7 billion, representing just 0.1% of total assets.

Chart 2

North America

U.S. and Canadian banks have minimal direct exposure to Russia and Ukraine. In the U.S, no bank listed Russia or Ukraine on a regulatory filing that requires disclosure of country exposures exceeding 0.75% of assets. BIS data indicates exposure to Russia was under 0.1% of assets in the U.S. banking system (see chart 2).

We believe Citigroup Inc. has the largest absolute exposure to Russia of any bank in North America, and the conflict could also complicate its plans to exit consumer banking in the country. Still, the $8.2 billion exposure it has reported to Russia equated to only about 0.3% of its assets and about 5% of its S&P Global Ratings total adjusted capital (the numerator of our RAC ratio, which was 8.6% at June 2021). Its exposure includes corporate and consumer loans, local government securities, and deposits with the RCB and other financial institutions. On top of that, it said it had $1.6 billion of exposure to Russian counterparties not held at its Russian subsidiary. The company has estimated that under a severe stress scenario related to the conflict, its losses would equate to less than half of those exposures, or around 2%-3% of its S&P Global Ratings total adjusted capital.

Only two of the other seven global systemically important banks in the U.S.--Goldman Sachs and Bank of New York Mellon--disclosed exposure to Russia in their 2021 annual reports. Both showed minimal exposure. None of the others, including JPMorgan Chase & Co.--the most global of the U.S. banks after Citi--listed Russia or Ukraine among their largest country exposures (usually the 20 largest).

Asia Pacific

For banking systems in Asia-Pacific, direct exposures to Russia and Ukraine are very low. The Japanese banking system, which includes three G-SIBs, has limited direct exposure to Russia. Total Japanese banking exposures to Russia were a paltry US$9 billion at Sept. 30, 2021, according to BIS data--about 0.2% of total assets. Exposures in other BIS-reporting jurisdictions, including Australia, Korea, and Taiwan, are also very low. For China, which is not included in the BIS data, Russian exposures do not appear to be significant as a proportion of total Chinese banking sector assets, which include the infrastructure investments of certain Chinese policy banks. Banks in south and south-east Asia also do not have meaningful direct exposures to Russia.

Many Asian economies are net importers of oil and commodities, and potential higher inflation could dampen their growth, which will stress some bank borrowers in jurisdictions such as in India and Thailand. Conversely, banks in commodity-exporting countries, such as Malaysia and Indonesia, could incrementally benefit, noting economic trends in both these jurisdictions are currently negative (prior to the onset of the Russia-Ukraine conflict).

While direct exposures are very low, we are mindful that evolving geopolitical situations, or upheaval associated with major unexpected events such as cyber attacks, represent key downside risks.

Middle East And Africa

We see very limited direct exposures to Russia and Ukraine for rated Middle East and African (MEA) banks, and we do not expect these exposures to meaningfully affect their profitability or cost of risk.

That said, the conflict has triggered a significant increase in energy, transport, and food prices because of higher commodities prices including oil and gas, and we have revised our 2022 oil price assumption to $85 per barrel from $75 (see related research). As such, the conflict's effect on economies in MEA--which will ultimately flow through to their banking systems--depends on how resilient they are to external shocks, which is itself tied to economic diversification and wealth levels. Clearly, oil-exporting economies are likely to benefit while oil importers could suffer. Tourism may also be affected, noting that some countries depend more on Russian tourists--UAE, Turkey, Egypt, and Tunisia. The conflict could also dampen investor risk appetite. In MEA, we think Qatar, Turkey, and Tunisia would be the most vulnerable in this regard given the high external debt in their banking systems (Qatar and Turkey). For Tunisia, it could affect its government's ability to strike a deal with the IMF to finance its deficit for 2022.

Latin America

Direct exposure to Russia and Ukraine in Latin America's banking systems is minimal, and we do not expect any ratings impact. As is the case for other regions, we do see potential risks from second round effects arising from higher oil prices, increasing inflation, and weaker economic growth, which in turn could pressure bank asset quality and profitability. In addition, weaker investor confidence could also result in higher financing costs for the region's financial institutions. That said, most of the region's banking systems have relatively low dependance on external funding, which should mitigate this latter risk to some extent.

Financial market infrastructures

As sanctions seek in part to substantially isolate Russia from global financial markets, there are inevitable implications for financial market infrastructures--although we see this as a predominantly operational issue for now, and unlikely to affect associated ratings. Euroclear Bank and Clearstream Luxembourg, the international central securities depositories, are lynchpins that connect the international and Russian markets. Sanctions and Russian capital controls effectively forced them to suspend settlements in Russian domestic securities and in rubles, and to turn away cash deposits from Russian institutions. Exchanges and clearinghouses, notably but not only in Europe, have suspended or delisted securities and derivative contracts, suspended a handful of sanctioned trading or clearing members, and employed heightened risk monitoring in response to market volatility. In this respect though, the spike in volatility has typically so far not equalled that seen in March/April 2020 or after the Brexit vote in 2016, and the clearing members of rated FMIs have met margin calls.

Mastercard Inc. and Visa Inc. derived about 6% and 5%, respectively, of their net revenues from domestic and cross-border business conducted in Russia and Ukraine in their latest fiscal years. Both companies have said they are in the process of complying with global sanctions. If those sanctions remain, we would expect net revenues from those countries to fall sharply. Still, Mastercard and Visa are likely to more than offset that pressure with growth in the rest of the world. Economic growth and a continued shift to electronic payments has been driving net revenue growth well into the double digits for both companies.

Downside Risks Are High And Second-Order Effects Could Yet Have Broader Impact, Notably In EMEA

We remain very mindful that potential second-round effects--from slower economic growth, persistent high commodity prices, inflation, and financial market volatility and repricing-- could prove particularly unpredictable given not only the dynamic geopolitical situation but also the unprecedented decoupling of a major global economy spurred by sanctions and related commercial decisions. This adds risk and complexity to the already-heightened geopolitical tensions outside the immediate conflict zone. This could ultimately play out badly for banks, albeit the impact will most likely be credit-relevant for EMEA financial institutions, not least those active in economies and facing corporates that are the most closely intertwined with Russia. At the very least, we anticipate that slower economic growth prospects could crimp revenues and lead to modest additional credit losses, on top of any losses on direct Russian exposures. This points to it being fundamentally an earnings, and not capital or liquidity, story. But the effects are unlikely to be felt evenly across European economies or European banks.

Beyond these attendant credit and revenue risks, banks face heightened operational risks, whether from a ratcheting up of cyber and counter cyber attacks between Russia and its perceived adversaries (see box 2), or the tricky implementation of sanctions and other controls that often requires banks to skilfully navigate legal uncertainty.

Appendix

Recent sovereign and bank rating actions

Sovereign rating actions

• Russia Ratings Lowered To 'CCC-' And Kept On CreditWatch Negative On Increasing Risk Of Default, March 3, 2022
• Russia Foreign Currency Rating Lowered To 'BB+' And Put On CreditWatch Negative On Risks Related To Invasion Of Ukraine, Feb. 26, 2022
• Ukraine Long-Term Ratings Lowered To 'B-', Placed On CreditWatch Negative On Fallout From Russia's Military Attack, Feb. 26, 2022

Financial institutions rating actions

• Hungary-Based OTP Bank Ratings Affirmed Despite Escalating Ukraine Conflict, Outlook Remains Stable, March 3, 2022
• Austria-Based Raiffeisen Bank International 'A-' Ratings Affirmed Despite Escalating Ukraine Conflict; Outlook Negative, March 3, 2022
• Various Negative Rating Actions Taken On VTB Bank Kazakhstan And VTB Bank Georgia; Ratings Suspended, March 1, 2022
• Kazakhstan-Based SB Alfa-Bank JSC 'BB' Ratings Placed On CreditWatch Negative On Parent's Deteriorating Creditworthiness, March 1, 2022
• Belarus-Based Bank BelVEB OJSC Ratings Placed On CreditWatch Negative And Suspended Due To U.S. Sanctions, March 1, 2022
• Belarusbank And Belagroprombank Ratings On Watch Negative On Increased Risks Related To Russia-Ukraine Escalation, March 1, 2022
• Russian VEB.RF And Sub. Rtgs Cut To 'BB+' And Put On CreditWatch Neg After Similar Action On Russia; Rtgs Then Suspended, March 1, 2022
• Russia-Based Sovcombank PJSC 'BB/B' Ratings Placed On CreditWatch Negative And Suspended Due To U.S. Sanctions, Feb. 28, 2022
• VTB Bank Downgraded To 'BB+' From 'BBB-'; VTB Capital Downgraded To 'BB' From 'BB+', On Watch Neg, Then Suspended, Feb. 28, 2022
• Four Russian Banks Downgraded After Sovereign; Those And Other Financial Institutions Ratings On CreditWatch Negative, Feb. 28, 2022
• Bank Alliance Downgraded To 'CCC/C'; Put On CreditWatch Developing On Fallout From Russian Military Operation In Ukraine, Feb. 28, 2022
• Russia-Based Promsvyazbank PJSC 'BB/B' Ratings Placed On CreditWatch Negative And Suspended Due To U.S. Sanctions, Feb. 25, 2022

Other related research

• The Significance Of Some Russian Banks Being Excluded From The SWIFT System, March 4, 2022
• Cryptos Won't Blunt The Sting Of Sanctions On Russia, March 4, 2022
• The Failure Of Sberbank Europe: International In Life, National In Death, March 4, 2022
• Ratings Actions Waypoint: The Russia-Ukraine Conflict, March 3, 2022
• The Macro And Credit Effects Of Russia's Invasion Of Ukraine, Feb. 25, 2022
• S&P Global Ratings Raises Near-Term Oil And Gas Price Assumptions Following Russian Invasion Of Ukraine, Feb. 28, 2022
• Cyber Threat Brief: How Worried Should We Be About Cyber Attacks On Ukraine? Feb. 22, 2022
• Possible Credit Consequences Of Escalating Russia-West Tensions Over Ukraine And Further Sanctions Against Russia, Feb. 8, 2022