China’s small banks set for spotlight over Russia support

Bloomberg

China’s smaller banks could come under greater scrutiny over financing to Russia as the nation’s biggest lenders are already showing signs of complying with US and European sanctions in a bid to protect their large international footprints.
Within the commercial banking system, one model allowing China to support its strategic partner would be through an institution similar to the Bank of Kunlun, a small and unlisted state-owned lender which continued to finance payments to Iran even after Washington shut the bank out of the dollar market.
Small banks that don’t have any international business exposure will likely keep financing Russia and service payments, said Zhiwu Chen, a professor of finance at the University of Hong Kong Business School. “For them, the risk of potentially being sanctioned by the US and West European countries is not that high,” he said.
China’s overall willingness to support Russia is still unclear, with President Xi Jinping calling for negotiations over Russia’s invasion of Ukraine. The full extent of Washington and European Union sanctions are also still being worked out. The White House has said “selected” Russian banks would be removed from the SWIFT messaging system, though officials were also looking at exceptions for the energy sector.
But any candidate for financing to Russian entities sanctioned by the West would need to be willing to give up its access to dollar and euro markets, and face restrictions on foreign investment if they are listed on stock exchanges.
While continuing to deal with Russian entities sanctioned by the US and EU would not be illegal under Chinese or international law – China has not imposed sanctions on Russia and neither has the United Nations – banks run the risk of secondary sanctions if they do business with sanctioned entities, which can cut off their ties with US and EU investors.
“The US government could use secondary sanctions to go after people who are seen as circumventing the primary sanctions,” said Ben Kostrzewa, a consultant at Hogan Lovells in Hong Kong, who formerly handled US-China disputes and negotiations at the Office of the US Trade Representative. “These secondary sanctions, where there is no direct US nexus, will be a risk for Chinese companies if they engage in major transactions with restricted parties.”
Two of China’s largest state-owned banks, Industrial & Commercial Bank of China Ltd. and Bank of China Ltd. are restricting financing for purchases of Russian commodities, especially in dollars, according to people familiar with the matter. Both are large banks with close ties to the US and European banking systems, where violation of sanctions could see their operations curtailed.
“Chinese financial institutions, particularly the large ones, they tend to act like EU and US banks do — they follow all the same sanctions programs, they have internal control structures which are very similar,” said Nick Turner, a lawyer at Steptoe & Johnson in Hong Kong who advises companies on sanctions compliance.
Chinese banks had about $33 billion of outstanding lending to Russian entities in 2021, compared with $56 billion of EU and UK bank lending, according to Natixis SA estimates based on data from the Bank for International Settlements.
Some smaller Chinese banks have made Russia a priority. Hong Kong-listed Harbin Bank Co. said in its 2020 annual report that it had lent 8 billion yuan to Russian banks and had a foreign currency settlement network covering all of Russia.
The Bank of Kunlun, owned by China’s state-run China National Petroleum Corp., which was sanctioned by the US for Iran payments in 2012 continued to facilitate trade with Iranian companies using China’s currency.