International banks have taken an increasingly cautious approach to trade and payment flows in Eastern Europe and Central Asia since Russia’s invasion of Ukraine. Experts warn a trend towards de-risking is not only hindering legitimate commerce but could drive development of a shadow banking system. Felix Thompson reports.
Across Eastern Europe and Central Asia, trade finance bankers have witnessed a steady retreat of correspondent banks from their markets.
In countries such as Armenia, Azerbaijan and Georgia and those further east, including Mongolia, Kyrgyzstan and Tajikistan, there has been a widespread exodus over the past decade, in no small part due to soaring compliance costs.
As a result, many local banks have found their access to correspondent services, such as dollar clearing, significantly reduced.
There are now fears the situation is rapidly deteriorating in states that were once part of the Soviet Union, with trade finance banks – even reputable providers – becoming indirect victims of the Ukraine war.
“The challenge here is greater than it is anywhere else, and that’s led to this enhanced compliance risk with all the sanctions imposed against Russia,” says Shona Tatchell, head of the trade facilitation programme at the European Bank for Reconstruction and Development (EBRD).
“This is really causing massive ripples across Central Asia and the Caucasus,” Tatchell tells GTR.
In response to Russia’s invasion of Ukraine in February 2022, US and European powers kickstarted a series of sanctions targeting Moscow’s energy sector and restricting its ability to access vital products for its military activity, including an array of goods with both civilian and military purposes.
Last December, the White House established secondary sanctions threatening foreign banks – notably those in China – with expulsion from the US financial system should they deal with blacklisted Russian entities. In June, Washington announced it would expand this regime to cover over 4,500 Russian companies and individuals in a bid to stop Russia’s “reprehensible war effort”.
These sanctions are designed in part to prevent Moscow from sourcing goods via third countries, with International Monetary Fund (IMF) data indicating a spike in trade through former Soviet states.
EU exports to Armenia surged by 178% in the second half of 2022, compared to the same period a year earlier, while they grew by 116% to Kazakhstan and 537% to Kyrgyzstan, IMF data shows. These countries duly registered an uptick in sales to Russia, potentially indicating attempts at sanctions evasion, experts say.
Yet, in the Caucasus and Central Asia, there are growing fears over the impact of sanctions on legitimate trade flows.
Access to US dollars and euros is vital for trade finance banks when their clients are importing goods. Equally important are services like confirming letters of credit (LCs) and issuing guarantees. Without these, banks are finding it increasingly difficult to service their clients.
Anna Brod-Ohana, a senior banker at the EBRD, says de-risking in these regions “has been going on for a while, but the Ukraine crisis has made it worse”.
“In Central Asia and the Caucasus, they faced issues before, but they may have had one correspondent for dollars or were obtaining dollars through a Russian bank,” she says. “They didn’t have major US or European banks providing dollars pre-2022, but they had a Russian bank, and now that access has been terminated.”
Widespread disruptions
The impact of trade de-risking since the Ukraine crisis erupted varies across the former Soviet region.
Some countries are in a particular bind given their geographic location and historic and economic links to Russia, says Zuzana Franz, head of international banking sales at Oddo BHF.
“Uzbekistan, for instance, which is double landlocked and has ties with Russia… On one hand, they have to comply with all existing sanctions law and on the other, they cannot cut connections to Russia completely,” she tells GTR. “Therefore, they are in a very difficult situation.”
Uzbekistan’s foreign trade volumes reached US$36.8bn in the first half of 2024, with China accounting for 18.6% of this total, Russia 18.5% and Kazakhstan 6.2%, government data shows.
Exports to Russia were valued at US$2.1bn and imports reached US$4.6bn, rising about 40% in both instances from the US$1.5bn and US$3.3bn recorded in H1 2022.
Brod-Ohana at the EBRD says Central Asia as a region is “much more affected than the Caucasus” and there’s been a gradual shift in trade flows, with more goods moving east than west.
However, she notes that banks in Armenia, part of the Caucasus region, have also been hard hit by de-risking over the past two years.
Anzhela Barseghyan, director of trade finance and correspondent relationships at ArmSwissBank, says that while banks like Oddo BHF, UniCredit and UBS have continued issuing guarantees and confirming LCs, the Armenian lender has still faced significant challenges.
ArmSwissBank does not facilitate re-exports, so “our transactions have never been high risk”, she tells GTR. Even so, it has lost clients.
The bank partially obtains US dollars through a partnership with the Bank of Georgia, yet lacks a global correspondent bank to provide the greenback for cross-border payments.
This has indirectly impacted its trade finance business, and some customers have opted to leave, Barseghyan says.
“There could be a client which has to make 30% down payment in US dollars in order to import equipment and for the remaining amount would apply to us for issuing an LC, but unfortunately, we are not able to support the whole transaction,” she says.
Barseghyan also notes that some clients using supply chain or pre-export finance are unable to make US dollar repayments on their loans due to the bank’s currency constraints.
“We cannot serve these clients, and they are moving to other banks,” she says.
The bank’s clients largely import equipment from suppliers in China, Italy and Scotland.
Meanwhile, in Georgia, Tamara Khizanishvili, head of trade finance and factoring at TBC Bank, says the lender’s status as the largest bank in the country means it has maintained strong correspondent relationships with US and European institutions.
“The main challenge remains the slower processing of trade finance transactions and the increasing complexity of settlement processes. These delays are primarily due to the enhanced due diligence and stringent compliance checks now required,” she says.
The bank must collect “extensive information” about the trading counterparties, underlying goods and transport routes.
“Some transactions, even repeated ones, take days to be finalised,” she tells GTR.
Re-export risks
While some international banks have maintained strong correspondent ties to Eastern Europe and Central Asia, they are increasingly adopting a more risk-averse approach.
Elitza Kavrakova, group head of institutional clients at Raiffeisen Bank International, says there is significant pressure on large correspondent banks offering trade finance services in the region due to the “tremendously complex” sanctions regimes imposed by the US, UK and EU on Moscow and the efforts by Russian importers and exporters to evade these measures.
Raiffeisen had already halted business in Kyrgyzstan and Tajikistan in 2019 due to concerns over compliance risk in these markets.
But now the bank has taken additional precautionary measures in response to growing sanction risks.
“Sanctions have increased the compliance scrutiny,” Kavrakova tells GTR. “It is very difficult to prove in practice where the goods ultimately go, so banks have started rethinking their risk appetite and either stopped supporting trade flows into certain countries, or like us, introduced restrictions.”
In certain markets, the bank no longer processes payments or provides trade finance for high-risk goods such as electronics, oil and gas, wood and automotive parts, which are all currently barred.
In a bid to mitigate risks, Raiffeisen has also created a “self-built” tool to detect “simple cases” of sanctions dodging and developed a semi-automated process to compare a country’s trade data with its GDP growth to assess evasion risks, Kavrakova said at an event in Bratislava in October.
But she tells GTR that correspondent banks need greater access to import and export data, and “better interconnection” between local regulators, customs bodies and tax authorities is required to monitor changed trade flows and better assess and mitigate compliance and credit risks.
“To the best of my knowledge, there is no compliance tool which will allow me to screen the whole value chain, say from the EU into a Central Asian country, and from there, into Russia,” she says.
Oddo BHF is another financial institution that continues to provide correspondent banking services in the region, yet compliance checks are taking longer, and this is increasing internal costs, Zuzana Franz says.
“If a bank – whether from Uzbekistan, Mongolia or Azerbaijan – asks us to confirm an LC, which is our daily business, we are looking at all parties involved: the exporter, importer, delivered goods and the advising bank,” she explains. “For every transaction, we examine the origin of the goods, the transport route and transport companies, because transshipment via Russia is still allowed for certain goods in certain cases.
“If there are goods which might be considered dual use, we ask the exporter for the export declaration and the issuing bank to provide confirmation the goods will be used in the country by their client and not re-exported to third countries, especially Russia.”
Development banks to the rescue?
As the Ukraine crisis rages on, multilateral institutions have taken measures to ease the impact of trade de-risking.
The World Bank’s International Finance Corporation (IFC) extended US$35mn in trade and supply chain finance support across Central Asia in the year up to June 2024, including by issuing guarantees to confirming banks.
The Black Sea Trade and Development Bank is another regional provider of trade finance. In October, it signed a US$10mn deal with Armenia’s Evocabank comprised of US$9mn in SME financing and US$1mn for trade finance.
One facet of the EBRD’s approach has been to coax large European banks to grow their exposures, as its ability to provide guarantees hinges on a strong correspondent network. “There’s not much the EBRD can do without a confirming bank,” says Brod-Ohana.
“EBRD came to us about two years ago and said you are a major provider of trade finance products in Central Asia, you have very good business in Uzbekistan and Mongolia, you know the people and banks well,” recalls Franz at Oddo BHF. “They asked whether we could step into smaller markets like Kyrgyzstan and offer correspondent banking services for the banks.”
The Franco-German bank took a “selective approach” as Kyrgyzstan was a new market, and then spent about a year conducting enhanced due diligence on the three local banks.
“This was not a fast process,” Zuzana Franz says. “If you are entering a new, difficult region, you must know the counterparts, the systems, the people. You do not want to be the last man standing; therefore we closely cooperated with development finance institutions, like EBRD and the Asian Development Bank.”
Ultimately, Oddo BHF agreed to provide clearing services in the country.
The inclusion of smaller banks in the global financial system is “very important” to prevent them from seeking “other ways to pay”, she tells GTR.
At the same time, EBRD is also funding a “big programme” that provides compliance training to personnel at “all levels” within local banks. The development bank’s own compliance teams have also been working with confirming banks “so they understand the deep level of due diligence we do for a bank or a transaction”, Tatchell says.
There are hopes that advancements in compliance technology could also help mitigate risks for correspondent banks, enabling them to boost coverage for trustworthy clients in the Caucasus and Central Asia.
LexisNexis Risk Solutions, Fenergo, IMTF and Elucidate are just a few of the so-called regtech platforms that promise to automate know-your-customer (KYC) and compliance checks for money laundering and sanctions breaches.
The EBRD’s Brod-Ohana says “western banks are investing a lot into digital platforms”, adding that these solutions can also potentially allow banks to filter out sectors or trade flows that they “do not wish to see”.
“But these platforms are very expensive. They’re expensive for our region and for the amount of business they currently have.”
Geopolitical risks
Despite the best efforts of multilateral institutions and optimism around technology’s ability to curb de-risking, experts warn the Ukraine crisis could drive local trade finance banks and their clients closer to Russia.
EBRD’s Tatchell says there is a “geopolitical consideration” to de-risking in Central Asia and the Caucasus.
“[If] you effectively cut off certain countries from access to US dollar clearing and prohibit them from being able to trade in US dollars, where are they going to look? They’re not going to look west. They’re going to look east. And that’s a huge consideration for the US,” she tells GTR.
However, she notes US policymakers are limited in their ability to tackle the issue alone.
Earlier this year, the EBRD asked the US Federal Reserve if it would encourage banks to provide dollars to trade finance banks. “The response that we were met with was, ‘It’s not really our problem to solve, it doesn’t affect us that much’,” says Tatchell.
“The view of the Fed was they are not going to tell the big banks to do this. It’s their choice, which is fair – you can’t tell Citibank or JP Morgan to keep US dollar correspondent relationships with banks in riskier markets as a matter of social obligation. It’s a free market, and it’s up to the banks to decide. But it does present a huge challenge.”
Brod-Ohana likewise says “de-risking is a real concern for the European Commission”.
“EU lawmakers are concerned that the bloc is losing European exports due to overregulation of the banks, and if they cannot support these banks by establishing limits for countries in the region, it is losing business,” she says.
“At the EBRD, we gave them examples of EU export transactions that were lost in our programme involving very prominent names, big brands, in sectors such as clothing, cars and machinery. Or if they weren’t lost, how much effort we had to put in – days and weeks of negotiations – with potential correspondent banks to accept our issuing banks with our cover.”
Broadly, there are growing fears over a bifurcation in both physical and financial supply chains.
As reported by Reuters, Russia is mulling the use of barter trading with China that would see the countries exchange goods, such as oil and electronics products, thereby removing the involvement of banks.
Experts say that crypto and stablecoins are also being used to settle cross-border trade payments.
“The main risk with de-risking initiatives… is that we are pushing the shadow economy,” said Martial Smets, a financial crime expert who has worked extensively with banks in Europe and Asia, speaking at a de-risking event in October.
“The bad business will use this, but also good business. We are basically creating another problem for the future.”
