The Russia risk around Chinese banks is rising

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China’s lenders were once considered some of the country’s safest investments. The relatively stable returns on offer from investing in shares of the largest state-owned banks came with the added benefit of fat dividends. Those days may be numbered.

There are two big risks. The first is well known: China’s continuing property crisis. The second less so: Russia.

After the invasion of Ukraine, a wave of sanctions from countries including the US left Russia heavily dependent on China — one of the few country’s left that would buy Russian coal. It became crucial in providing its ostracised neighbour with financial services.

After Russia’s central bank lost access to a big chunk of international reserves the renminbi offered one of its few remaining options. The absence of Visa, Mastercard and American Express, which suspended operations in Russia in 2022, meant China’s UnionPay was the only service left. This meant that the renminbi’s portion of global payments surged to 4.6 per cent in November, according to Swift data, surpassing the Japanese yen. That makes it the fourth most active currency in the world.

Chinese lenders had distanced themselves from big Russian clients in 2022, when international sanctions first kicked in. Nonetheless, their exposure to Russia’s banking sector has increased, having already quadrupled in the 14 months to the end of March last year. For China’s smaller banks, this business would have been a welcome source of additional revenue.

It increasingly doesn’t look worthwhile for bigger lenders. US laws and enforcement policies require foreign financial institutions that engage in US dollar transactions to comply with sanctions, or face steep penalties. In the worst case, there is the threat of restrictions on all sources of US dollar liquidity. At the end of last year, the US granted the Treasury new authority to penalise foreign lenders doing business with certain Russian sectors, even where there is no US connection to the transaction — so-called “secondary sanctions”.

0.4xChinese banks’ price to tangible book ratio is among the lowest in the region

Those penalties would far outweigh the small boost to sales Russian clients mean for the largest banks, such as Industrial and Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China.

The rising risk of US sanctions is another challenge for a sector already struggling with supporting the local property market, as the largest lenders are called on by Beijing to bail out indebted developers. Chinese banks’ price to tangible book value ratio, at just 0.4 times, is among the lowest in the region.

As state-owned banks, the downside risk from those requests is not something they can avoid. But exposure to Russia is one that they can.