U.S. Sanctions Said to Spook Russia Banks Funding Arms Buys

(Bloomberg) -- The new U.S. sanctions law threatens to cut off a vital channel for Russia’s funding of its massive defense buildup, according to four people familiar with the situation.

Officials in the government and state banks -- Sberbank PJSC and VTB Bank PJSC are the biggest players -- are looking for ways to get around the restrictions or minimize their impact on the funding, these people said, speaking on condition of anonymity to describe confidential official deliberations. Some financing has already been delayed, one of the people said. The military expansion is a top priority for President Vladimir Putin.

The previously undisclosed problems highlight how the sanctions law, signed by President Donald Trump last month, threatens to crimp business in Russia despite the Kremlin’s assertions that its impact will be limited. The main provision of the law gives Congress the power to block the president from easing restrictions. The legislation also allows for expanding sanctions on a wide range of sectors, from mining and energy to military industries.

‘Nothing New’

At the time the law passed, the Kremlin dismissed the new limits as “nothing new,” but in retaliation later ordered the U.S. to slash two-thirds of the staff at its embassy and consulates.

One section in the new law mandates that the president to impose additional sanctions on anyone doing “significant transactions” with the Russian military or intelligence sectors, with the limits to be introduced 180 days after the law took effect. They could go as far as cutting off access to the U.S. financial system and seizing assets held in the U.S.

The law’s provisions have led Sberbank and VTB, Russia’s main state-owned banks, to worry that the large loans they make to weapons producers could expose them to such sanctions, crippling their business, these people said. While the banks already are subject to restrictions on their ability to raise financing, the new provisions include more sweeping limits, such as a ban on holding accounts at U.S. financial institutions or access to foreign currency.

U.S. Sanctions Said to Spook Russia Banks Funding Arms Buys

While the defense lending is clearly a priority for the Kremlin, banks that continue it “are running risks under the U.S. sanctions,” said Edward Krauland, head of the sanctions and export practice at Steptoe & Johnson in Washington. “It’s a difficult situation.”

Among the options the Russian government is considering to resolve the issue is the creating a new state-owned bank to finance defense spending or making the expenditures directly from the treasury, the people said. The latter option could raise costs and possibly boost government borrowing.

‘Lucrative Business’

Russia is in the midst of its largest military buildup since the Cold War, spending a total of 20 trillion rubles on new aircraft, ships, missiles and other armaments. Much of that is handled through the state banks, which provide loans to the arms makers and are later repaid by the government. Sberbank and VTB handle about 90 percent of this lending, having provided about 197 billion rubles ($3.4 billion) through the mechanism last year, according to estimates from Vasily Zatsepin, an expert on defense spending at the Gaidar Institute, a Moscow think tank.

“For Sberbank and VTB, being forced to give up the lucrative business of lending to the military industry will be a blow,” he said. He noted that removing the banks from the process also would likely lead to higher costs, as the lenders provided oversight that the government typically hasn’t. The press services of the Finance Ministry, Sberbank, and VTB declined to comment.

U.S. Sanctions Said to Spook Russia Banks Funding Arms Buys

The U.S. hasn’t published regulations spelling out the details of the new sanctions.

“It’s a very broad and in some ways ambiguous law which makes it difficult for a Russian company or for a company anywhere in the world,” said Daniel Waltz, a partner at Squire Patton Boggs in Washington. “Banks are asking themselves -- should we simply terminate our relationship with every sanctioned entity,” he added.