Impact of the Russia-Ukraine Conflict on European Banks
I consider the last two years as my personal Masterclass in banking. Every week I get the chance to ask an executive my questions to help me understand the wonderful world of banking.
The session on April 14 was no exception and probably one of the highlights so far. We spoke about the impact of the Russia-Ukraine conflict on the banking industry. It was an absolute honour that Sandra Phlippen accepted my invitation to join us as the central guest.
Sandra is not only Chief Economist at ABN AMRO Bank, but also an assistant professor at the Erasmus University and external advisor of the Dutch Council of State, to name a few of her roles. It was her second visit to The Banking Scene Afterwork, after a session back in 2020 on "Society and Banking in 2030", in which we discussed how the pandemic was disrupting the way we live and the way we think about our future.
What I love about having her in our sessions is that she has the capability of linking day-to-day life and society to banking with the required deep dives to understand how one impacts the other.
What's more: she has the unique skill set to do it in an understandable manner. Suddenly you understand how even a South African local savings bank can be impacted by war in Europe.
We cannot look at the war without looking at the pandemic
Or how about this one: if we want to understand the impact of the war in Ukraine, we must first look at how governments dealt with the pandemic.
During the pandemic, Europe supported its economy by massively helping companies survive, whether they had a healthy P&L pre-pandemic or not. As Sandra explained, the result was a frozen economy: "natural dynamics of entry and exit of firms, workers and capital moving to the most productive places in an economy, those things were basically not happening."
In the short run, that is no problem, but the long-term impact is lower productivity and a loss of competitiveness.
The United States, on the contrary, let the market play and supported the lower-income half of the population, consumers. They started consuming massively, leading to price increases, which in turn led to wage increases, resulting in a spiral of more price increases.
Because of consumer support instead of company support, the US saw the Big Quit phenomenon, where about 30% left the labour market for early retirement etc. and never entered the labour market again, leading to even more wage increases in the war for talent. Altogether, the US economy is now suffering a longer term inflation because of these effects.
The high inflation in Europe that we measure today, is the result of the war, and unlike in the US, less because of the pandemic, explained Sandra. This inflation is directly related to the price increases in the energy market.
Price increase happened in Europe because of the higher production cost and scarcity, not so much because of more consumption. The ECB cannot control external events that impact supply-side inflation, but they are doing everything they can to intervene in the domestic drivers of inflation.
Sandra: "Hiking (higher interest rates) is an instrument to prevent supply-side inflation from becoming entrenched into the broad set of price increases in society. The difficulty here is that the ECB is trying, on the one hand, to prevent inflation from trickling down, but on the other hand, inflation is also eroding real wages". A fall in wages will generate a lower growth, which may start a recession with deflationary effects on the economy.
The direct impacts of the Russia-Ukraine war on banks
I list the 5 main direct impacts here, but of course, there are more, depending on the bank we talk about.
One: How big the impact of the war is for banks depends mainly on a financial institution's exposure to Russia.
Two: Sandra pointed at another direct impact: self-sanctioning. "We should not underestimate the impact of the self-sanctioning that happened in the financial sector. The Swift structure is a very complicated network. Many banks were afraid to, by accident, cross the line and therefore stayed far away from the red line, and that led to a lot of self-sanctioning, which was very harmful."
Three: A worry I never thought of that may harm the financial industry is the impact of the conflict on the food industry. Farms across the world depend on Ukraine for fertilisation. Sandra explained how these supply chains are broken today. We can expect next year's harvest to be very weak, leading to hunger and starvation in developing economies, which cause political unrest and potentially new wars.
In a way, we start to see that it is not just exposure to Russia that banks should be afraid of, but developing countries in general. This was another eye-opener for me.
Four: The price shocks from the energy crisis are another element that impacts the entire financial industry. Sandra: "Within two weeks after the initial energy price shocks, we saw that private organisations started self-sanctioning and staying away from Russia. The whole behavioural dynamic when scarcity arises kicked in. Everybody started hoarding, leading to a disruption in trade flows." These disruptions are expensive and put more pressure on the prices of goods and services.
Five: Central banks need to find solutions to cope with inflation. Needless to say that rising interest rates or the stop of asset purchase programs have a direct, positive impact on the financial results of banks.
Reviewing localisation and the 15-minute economy
Back in 2020, Sandra joined us for a macro-economic view on Jo Caudron's prediction of society in 2030. One of the central ideas was the rise of the 15-minute economy. Deglobalisation and circular living are the anchor points of this society, where everything one needs, should be reachable within 15 minutes.
Sandra: "We have about 500 Gigatons of co2 emissions left in the world, and we emit about 60 per year, so we have eight years to go and then it's just done. Otherwise, we're just not going to stay within the one and a half degree."
Sandra believes that only through globalisation do we have a chance to achieve a sustainable future, not through deglobalisation, where each community takes care of itself.
Another concern she raised was the trade-off that society might need to make to shift to the 15-minute economy: how can we make the shift affordable to all and avoid leaving people behind?
Sandra: "It has to be socially inclusive, and it has to be pre-financed. I think the government and the financial sector play a huge role. It would be very wise to allow for green government debt. The stability and growth pact that is now being renegotiated should leave room for countries having much more Green debt to pre-finance the transition so that the middle and lower class will not be paying very high prices."
On the other hand: who is going to spend all these debts? An ABN AMRO Bank study found 52 crucial roles for the energy transition, and the interest from applicants is simply not enough. Sandra explained: "The Dutch government has 35 billion euros lying on the table for the transition, but the money just can't be spent because they're not the hands to do the work."
Everyone spoke about SWIFT and how the isolation of the Russian financial system affected the banking industry in Europe. Thanks to this session, I got a much better view of how the Russia-Ukraine conflict affects the banking industry, which is clearly not just today and yesterday but also tomorrow.
It started with the effects of self-sanctioning, and today, we don't know where it will lead.
Will it speed up the pace to a greener society as governments try to make themselves more independent from the Russian energy supply? Perhaps it will, although we should not forget the positive effects of a global economy. After all, it is the only way we can afford to evolve to a sustainable and greener future.