Can Banks Stop Russia and China from Evading Sanctions?

February 19, 2024 Topic: Economics Region: Global Tags: SanctionsExport ControlsFinanceU.S. TreasuryRussia

Can Banks Stop Russia and China from Evading Sanctions?

As the U.S. imposes export controls on global adversaries, banks are scrambling to stay compliant.

The twenty-first century ushered in a “new era of financial warfare” as the United States imposed robust financial sanctions on its adversaries. Unlike traditional trade sanctions, these measures focus on disrupting a target state’s cross-border financial channels to isolate it from the global economy. However, this also allowed America to leverage the dollar’s status as the world’s reserve currency. Furthermore, relatively few giant banks are responsible for most global cross-border transactions, relying on the U.S. dollar to carry out basic operations. Blocked access to the dollar is an effective death sentence for most major financial institutions. 

Hence, banks quickly adopted American preferences regarding legal practices—what some scholars call the Americanization of compliance—and erected massive compliance bureaucracies elevated from middle offices to core nodes within the firms’ operations. It is not unusual for 10 percent of the staff of an individual bank to be compliance professionals. Now, the Biden administration is placing them at the center of the West’s most pressing sanctions necessity: enforcing export controls. 

While financial sanctions still have an essential role for the United States and its allies, the focus has shifted to export controls. Economic sanctions were very influential in undermining the economies of countries like Iran, Syria, and Venezuela. However, as sanctions become a weapon of choice in the era of great power competition, export controls are taking the spotlight. The need to restrict Russian military and economic access to high-value Western technological products and slow down China’s fast-expanding military and industrial base has made Washington rediscover enthusiasm for technological export controls abandoned in favor of promoting free trade after the Berlin Wall fell. 

The Treasury and Commerce Departments, responsible for financial sanctions and export controls, respectively, have issued multiple joint notices in June 2022, October 2022, and May 2023 urging vigilance on the part of banks to identify, investigate, and report suspicious financial transactions underpinning export control evasion schemes. Yet, just before Christmas, the White House issued an executive order imposing new requirements on international banks, excluding those handling Russian transactions from the U.S. financial system and potentially freezing their U.S. assets. 

Why The Banks?

Analysts broadly agree that the results of export control measures have been mixed. U.S. export control officials have been counseling patience, arguing that these measures take time for their full impact to manifest. Technology and high-tech manufacturing firms are not accustomed to carrying out the foreign policy objectives of their home countries. International technological supply chains are incredibly complex and difficult to police, just like financial flows. 

The digitization of financial records and the increased centrality of global financial infrastructures, primarily based in the West, make tracking and interdicting financial transactions and complex bank vetting procedures somewhat easy, creating a panopticon effect with exploitable chokepoints. There is no equivalent to this in the realm of technology, with firms already acknowledging how difficult it is to police where their products end up after sales are made. 

As such, Washington has increasingly sought to rely on banks to carry out export control functions, as financial services institutions have a significant degree of visibility into the sanctions trade of technological products. They can also facilitate these transactions through cross-border payments and provide services such as processing letters of credit or issuing credit to the parties involved. Washington hopes to leverage banks' existing sanctions compliance capacities to compensate for the limitations among technology and high-tech manufacturing firms.   

Challenges for Banks 

Banks are ill-equipped to roll out sophisticated export control regimes, as the traditional compliance model primarily relies on exporters undertaking the requisite due diligence. In trade finance, for example, parties to such transactions can be screened against sanctions lists. However, inspecting the underlying goods is more challenging. For one, banks may not have access to critical documentation, much of which is still paper-based, or be privy to only one leg of a transaction, making scrutiny challenging. 

Recognizing this weakness, Moscow has assembled sophisticated sanctions evasion networks to source embargoed components, going as far as sharing a list of critical items with its allies and authorized parallel imports to offset sanctions restrictions. This explains how banned items like luxury sedans can still be found in Moscow showrooms.  

Arguably, the financial instruments most critical to sanctions evasion are trade finance products used in international commerce, such as letters of credit and bank guarantees. Recent prosecutions by the Department of Justice reveal that Moscow’s agents keenly understand U.S. export controls and their limits on sensitive technologies, making the usage of trade finance products and shipping to third countries a classic, recurring scheme. 

To fully address the requirements of the new executive order, banks will need to develop novel, risk-based approaches for mining internal data to garner insights, including reviewing internal country risk ratings for “evasion” jurisdictions that have been highlighted by regulators, such as India, the United Arab Emirates (UAE), Cyprus, and Israel. Inexplicable spikes in payment or trade volumes, coupled with insights on the nature of these spikes (personal remittances versus electronic exports), can also provide crucial intelligence in uncovering evasion networks.  

A proactive and continuous review of clients and a targeted review of higher-risk business activities from a sanctions evasion perspective will be essential, surpassing the scope of conventional anti-money laundering. Staffing these roles will be challenging, as the skillset to simultaneously vet financial services in the context of export controls and geopolitical security dynamics is unique and rare. However, regulators have signaled that cracking down on sanctions evasion is a priority for the G7, and the likelihood of sustained, billion-dollar enforcement actions against foreign financial institutions, akin to the experience of European banks in the early 2010s, is possible. 

Inevitably, clashes between regimes may also arise, further complicating global banks’ ability to comply with different regimes. The Russian sanctions imposed by the West have also seen substantial counter-sanctions imposed by Moscow. While nowhere near as significant, these restrictions have nonetheless frozen large pools of Western capital within Russia, with the Kremlin threatening to nationalize these assets if Brussels seizes interest payments accruing within the European Union’s financial system. Export control cases are even more complex, given the interdependent nature of international supply chains. For instance, strategic export controls by China on the export of critical rare earth minerals could disrupt manufacturing activity.

The new measures and the present threat have already borne some fruit. Chinese banks are now showing increased hesitation in facilitating Russian transactions. Beijing may publicly advertise its “no-limits” partnership with Moscow, but even state-owned Chinese financial firms have risk calculations. This echoes the Iranian and North Korean precedents for China, which isolated trade with these states to specific regional state-owned institutions.

Ultimately, the effectiveness of these measures will face challenges and take time. International banks will require time to implement complex and costly systems to meet the new requirements. Imposing devastating sanctions designations on Chinese banks would escalate Sino-American competition beyond what the Biden administration is comfortable with. However, the success of this new approach may define great power competition for years to come. 

Ali Ahmadi is a scholar of sanctions and geoeconomics. He is an Executive Fellow at the Geneva Center for Security Policy (GCSP) and a Research Fellow at the Brussels-based Vocal Europe foreign policy think tank. You can follow him on Twitter at @AliR_Ahmadi.

Owais Arshad is a former management consultant on geopolitical developments, sanction regimes, export controls, sovereign risk, trade, and emerging markets. His work has appeared in Nikkei Asia, Al Jazeera, the New Arab, and Euromoney.