Below is a lightly edited transcript of the podcast:
JOHN HELTMAN: I'm doing a podcast about Russia and Ukraine. And I know that you have feelings about Russia and Ukraine, right?
JAMES HELTMAN: So I was just gonna say like, that, like, this is how the war are all started.
HELTMAN: This is my son.
JAMES: My name is James.
HELTMAN: How old are you, James?
JAMES: Five. So, right, Russia said that, 'Hey, why don't you be part of us now?' But Ukraine said, 'Well, we kind of like being our own country.’ But Putin's Russia said, ‘Well, we have a bunch of guns and bombs. So we'll just invade.' And that's how the war all started. But actually, Ukraine ... small, small, but winning! Ukraine has been winning the war a lot. Because it has better fighters. They maybe smaller, but does have better fighters.
HELTMAN: In February the Russian Federation invaded the sovereign nation of Ukraine and, perhaps unintentionally, my son’s imagination. I think he knew what a war was before this, but something about this conflict has captured his attention. That’s not unusual — I was really into G.I. Joes when I was his age, and like me turns every stick he finds with a fork in it into an imaginary gun. But when I was a kid I thought war was exciting — grown-up, like an adventure. But this conflict seems to be hitting him in a different way.
HELTMAN: How did Russia's invasion of Ukraine make you feel?
JAMES: Um, scared. And I want to know more about war. That's why I've been asking a lot of questions about war recently.
HELTMAN: Do a lot of other kids in your class think about Ukraine?
JAMES: Well, uh, not that much. Some of them don't really know about the war. I may I made my teacher a Ukrainian flag.
HELTMAN: Yeah?
JAMES: Yeah. Out of Paper anyway.
HELTMAN: Russia’s invasion of Ukraine changed a lot of things in a fairly short period of time. Russia’s failed attempt to take over the capital of Kiev and eliminate Ukraine’s government failed, defying expectations. The remarkably unified response from the United States — and particularly from its European allies — has proven remarkably durable, with Western countries acting in unison to almost comprehensively isolate Russia from the global economy. And the bravery and defiance shown by the Ukrainian people has been not only inspiring, but militarily effective.
But while the imposition of the sanctions regime against Russia has been politically popular and effective, it has also come at a bad time and with considerable costs. Inflation is up all over the world, and key commodities like wheat and oil are harder to come by on the international market because of the war and resulting sanctions. And there aren’t many off-ramps for this standoff between Russia and the West on either side: Russia is unlikely to accept defeat, and the West is unlikely to relieve sanctions unless there is some reason to think Russia isn’t a threat to its neighbors.
That leaves banks with the difficult task of navigating a near- or even medium-term global economy that includes the very real prospects of an expanded military conflict on the one hand and a smaller world with which to safely conduct business on the other. So where does the financial system go from, here, and what happens if this drags on, and on, and on?
From American Banker, I’m John Heltman, and this is Bankshot, a podcast about banks, finance, and the world we live in.
The war in Ukraine is fast-moving — in the time since I started reporting out this podcast the Russian army withdrew from the areas surrounding Kyiv and refocused its efforts in the east of the country; the city of Mariupol on the southern coast was overtaken by Russia, and Ukranian forces have begun to counterattack in the northeast of the country.
Wars happen all the time, and global powers countries react to those wars all the time. What’s different about this conflict is that 1) the aggressor is a global power, and 2) the world has reacted to that aggression in a dramatic way. But don’t take my word for it.
ADAM POSEN: I'm Adam Posen, president of the Peterson Institute for International Economics. This is unprecedented. You have to go back really before World War Two, to sanctions that were put on Italy's invasion of Ethiopia, to find anything comparable, because it's not just the breadth and depth of the sanctions, it's the fact that you're doing it to what, at least ostensibly, is a major military power, a member of the G 20. And not ostensibly, really a nuclear power. So you know, this, this is a very big deal. The nature of the sanctions, is really a reflection of the nature of revulsion against the Ukrainian invasion by Russia, in the sense that it's all across the western ... why, it's not just countries in Europe, it includes countries that often don't get involved in sanctions, like Sweden and Switzerland that often are neutral. It includes countries like Japan, South Korea, Singapore, that were not directly affected.
HELTMAN: The Russian Federation is not unfamiliar with being subject to sanctions — in fact they had already been under U.S. sanctions for almost a decade following the annexation of the Crimean peninsula from Ukraine in 2014.
CLAY LOWERY: In terms of sanctions, let's just put them into a variety of different buckets.
HELTMAN: This is Clay Lowery.
LOWERY: My name is Clay Lowery. I am the executive vice president of the Institute of International Finance. Those sanctions were in some different areas, I would say probably the key ones, particularly for thinking about it today were there was some sanctions on some loan activity with Russian financial institutions. There were individual sanctions on specific Russians. Now those sanctions are usually things like freezing assets overseas, if possible, not allowing them to travel. So denying visas, that type of thing. And then third is there was some sanctioning on Russian on, particularly in the United States, about owning Russian debt.
HELTMAN: With the invasion of Ukraine, Russia likely expected those sanctions to remain in place and perhaps tighten somewhat. But what ultimately came to pass was far more dramatic than that.
LOWERY: When Russia invaded Ukraine on what February 24 The that sanction regime ratcheted up substantially and it again, I would say, in a few areas, let me focus on probably three core ones, although the ones I just mentioned are still quite important. First was the sanctioning, at kind of almost any type of transaction level, not just longer term loans and so forth with the major Russian financial institutions, by the United States and Europe, and again, some other jurisdictions as well, including Japan. And those sanctions are to basically say, you just can't do transactions with these institutions. U.S. authorities have said that this is roughly around 80% of the Russian banking system. Now, we need to be careful, because it's the sanctions are not the same for each of these institutions. So you have to, so it's not exactly perfect across the board. And there are some Russian banks that are not being sanctioned yet, or they are the sanctions are very minor. Alright, issue two, was the one that actually seemed to be getting a lot of attention in the press, which is whether or not to sanction Russia's ability to use Swift, alright, for your listeners, Swift is a messaging system, it is not a payment system, it is not a clearing system is not a settling system, it is a messaging system. And you basically send messages to say, 'Hey, we've done this transaction, and here's a message confirming it.' It's a very important system. And then the third one, I think that caught a lot of people by surprise was sanctioning the central bank. This is that is very, very rare.
POSEN: Even during World War II, the Central bank of Central banks — the Bank for International Settlements — was still really doing things for the German Reichsbank, for example. So I'm the bottom line is, you first have essentially a total cutting of Russia out of the global financial system. And doing so in a way, that means even when they have money on the table, or even when they have the Ruble, now officially trading at something similar to what it was before the invasion, they actually can't use the money. The money is all bottled up.
HELTMAN: And as I said, Russia to some extent expected that it would get sanctioned for what it also expected would be a swift and decisive defeat of its neighbor, and had been building up capital reserves in various currencies in various countries around the world to hedge against that possibility. But the international sanctions regime neutralized those reserves fairly comprehensively.
LOWERY: When they sanctioned it, it was probably the biggest chip at this kind of idea of a fortress Russia. The fortress Russia was built up by the Russian Central Bank, grabbing a lot of reserves over time from, particularly from oil exports. And what the Western authorities did, whether it's, again, the United States, or Canada, or Europe, or Japan or Singapore, was they basically said, 'We'll do two things: one, we'll freeze the assets, the existing assets of the Central Bank, which the central bank holds its assets all over the world; and secondly, we're going to not allow for transactions to occur.' So if the central bank needs to protect the ruble or do something like that, it can't do simple transactions to do that. So that was a big deal.
HELTMAN: This isn’t the first time an international coalition has concentrated its economic might against a single malignant nation: the sanctions regime against the Islamic Republic of Iran to curtail its nuclear program a decade ago was very comprehensive and ultimately effective in compelling an agreement. But what’s different this time is there isn’t a clear way for Russia to say “Uncle” — there’s no obvious off-ramp to this conflict.
POSEN: We've seen in Venezuela, in Iran, in North Korea, in Cuba, we've seen examples where even much stricter sanctions and much poorer countries were maintained for decades. And the regime we didn't like, still stayed there. So we can use words like powerful and the impact on Russia is, is indeed very large. But we should not kid ourselves that that means this is going to lead to Putin leaving. It might, but I wouldn't bet on it.
HELTMAN: So why should banks care about any of this? The first reason is that when Russian individuals are sanctioned by the U.S. government, you can’t do business with them, and the scope and depth of individual sanctions against Russian nationals means there are more entities that banks can’t do business with.
GREG BAER: Every time someone or some entity is sanctioned, that is something you need to take on board and effectuate through your compliance regimes.And I would add, it's not just U.S. sanctions, in this case. For our internationally active banks. There are considerable European sanctions, and even now, I think other countries, Asia as well. So everyone that people have to track all that interpret it and then effectuate it.
HELTMAN: Welcome back to the program Greg Baer.
BAER: Greg Baer, CEO and President, Bank Policy Institute.
HELTMAN: The Bank Policy Institute represents the largest, and for today’s purposes, most internationally active U.S. banks. And complying with a sanctions regime, even ones that are not as rapidly evolving as the ones against Russia, can be less straightforward than it might seem.
BAER: Over time, it becomes more complicated because once someone is sanctioned, they can they stopped doing business in their own name. And they begin using shell companies and surrogates. So a lot of sanctions compliance actually consists not of just sort of robotically running someone's name through your system, but actually doing the investigative work to try to determine what else that person or company might own, which can become quite involved, involve use of third party consultants, around investigative teams. You know, currently we're in the early stages of this, those those type types of investigations have only just begun. That will continue. I mean, the fortunate thing in this case is, you know, I think the U.S. government intelligence community is trying to find those people for the banks, which makes it a little easier.
HELTMAN: The U.S. banks that had business relationships in Russia — and there
BAER: A lot of the complexity currently is around how you disengage from those who have been sanctioned. You know, how, how do you end business relationships without doing collateral damage to innocent parties, whether those be European or American companies or individuals. It doesn't really help if you block a payment from a Russian company that's owed to someone in Europe. Well, that means that the Russian company keeps the money and the European doesn't get the money. So a lot of what's been going on, I think, in terms of interpretation, is we know how it what pace to you effectuate the sanctions and what payments are allowed to go through, at least for some time. I that again, and just more generally, the good news here is that the Treasury Department and OFAC had been absolutely terrific about being quite communicative with those charged with implementing the sanctions. They're ready to respond to questions, and they're being very collaborative about it. [8:13]
HELTMAN: The title of this piece alluded to whether banks should be worried about
But the other part of this podcast’s title, the prospect of a Cold War II, is far less hypothetical. The global economy has come to rely on relatively free trade all over the world — things are sold on the international market to the highest bidder, or are at least subject to global economic prices and trends. Russia’s overnight isolation from the global economy has been profound, but it has also been incomplete —
If that continues — if the war in Ukraine drags on, or gets worse — what we might see is a kind of bifurcation of the global economy into those who oppose the war on the one side and those who at least tolerate it on the other. And none other than Federal Reserve chairman Jerome Powell said during an International Monetary Fund panel in April that the free and easy international trade system we have come to know may not be the prevailing order in the near future.
POWELL: This series of events around Ukraine certainly has the possibility of leading to a more fragmented political situation and economic situation. You saw Secretary Yellen's speech this week about about looking to I think she call it French shoring. So I think there's a lot of thinking going on like that, you know, the globalization that we had had benefits to it, and it had costs ... costs involved in it. And you know, these are really questions more for elected governments, I would say than they are for the, for a central bank, but they would certainly be it'd be a different world, it might be a world of perhaps higher inflation, perhaps lower productivity, but more resilient, more robust supply chains, if we were to have ... I mean the supply chains that we had were very efficient, but quite fragile, it turned out. So and I think it's not clear that we're that we're seeing a reversal of globalization. It is clear, I think that it's certainly slowed down and it may go into reverse. I don't know.
BAER: I think that's the elephant in the room. I mean, I think as you know, China has taken a stance that does not seem to ... it certainly has not provoked action by the U.S. government, by definition. Obviously, sanctions on China would have a much greater impact on the US economy, U.S. firms, including the U.S. financial services firms, it would be an entirely different order of magnitude than than Russia. But so far, so good, I guess.
KAREN PETROU: I think there's no, no question in my mind that global finance is fragmented …
HELTMAN: That’s Karen Petrou, managing partner at Federal Financial Analytics.
PETROU: … along with global trade, and the increasingly tenuous institutions, like the World Trade Organization, are they relatively toothless, but hopeful institutions like the Financial Stability Board, these are going to be crumpling back into blocs — spelled B-L-O-C. With, as you pointed out, back to what I remember until the late 90s, you know, the US and its allies, Russia and its allies, and the non-aligned nations, China, India and some pretty significant emerging markets, playing everybody off to the greatest extent they could. These these systems depend on a completely ... a friction free cross border financial system, which we don’t have.
HELTMAN: To bring it back home, if the world is heading toward something like a Cold War II because of Russia’s invasion of Ukraine, the United States is unlikely to bear the brunt of that bifurcation. Russia and Ukraine are the
POSEN: One of the characteristics of the 50's, 60's, and particularly 70's, and 80's, is that developing countries often had to make a choice, which camp were you in? Were you in the, in the Cold War, were you with the communist Americans and, and a lot of investment, a lot of aid, a lot of international lending was very much conditioned. So you mentioned Egypt, there was the point of which Egypt threw in with the Soviet Union and Soviet Union built the
HELTMAN: All of this is hypothetical. No one knows what the future will bring, and it seems like the future has been getting harder and harder to predict with each passing year. But one thing that will make all of this better is if the conflict comes to a close sooner rather than later.
JAMES: They've been battling for about ... about two months by now. And I hope this war doesn't last the entire year. I hope it doesn't last two years, or three. I hope this this war ends soon.
HELTMAN: Me too, buddy.