On the eve of Russia’s 2014 invasion of Crimea, VTB Bank, the country’s second-largest lender, devoted an entire floor of its Imperia Tower headquarters in central Moscow to financing the money machine. country war.

Given the sensitive nature of the operation, access to the floor was forbidden to foreigners, according to former bank employees. The ban even extended to the foreign executive supposed to oversee the business unit.

“There was always a lot of mystery about what was going on in this department, but everyone knew he was funding the Russian military-industrial complex,” said a former senior VTB executive whose pass prohibited him from working. access to the floor.

In 2018, the Kremlin transferred defense loans to a small bank in an effort to shield VTB – as well as the country’s biggest lender, Sberbank, which has also funded the military – from sanctions.

“There is no banking system in Russia without Sberbank

But Vladimir Putin’s full-scale invasion of Ukraine means that VTB and Sberbank are now targets in a Western campaign to stifle the country’s financial system.

The sanctions – which have frozen VTB’s assets and will kick the group out of the global payments system Swift, while Sberbank has been barred from using the dollar – have already started to bite. Sberbank has been forced to withdraw from Central and Eastern Europe, and VTB is considering ending its European operations.

German authorities are closely monitoring VTB’s operations in Frankfurt, according to people familiar with the matter, aware that a disorderly departure could cost the country’s deposit insurance system billions of euros.

The two state-backed lenders had nearly a million retail customers across Europe, while managing accounts for local governments and hundreds of businesses. Their withdrawal from Europe, already underway before this year’s sanctions, marks the end of a two-decade strategy among Russian banks to expand internationally.

But it is here, where the two lenders represent nearly half of the banking market, that the sanctions will hit hardest. Executives at both banks fear frightened customers will rush to withdraw their savings and worry that restrictions on dollar funding will mean thousands of corporate customers could be starved of hard currency.

Just two months ago, Sberbank was Europe’s second largest bank in terms of market capitalization behind HSBC, while it remains the continent’s second largest in number of customers, with 102 million compared to Santander’s 148 million. Last year, it made a record net profit of $16.6 billion based on year-end exchange rates.

“There is no banking system in Russia without Sberbank,” said Ilan Stermer, director of banking research at Renaissance Capital.

Sberbank, whose roots go back to an 1841 decree by Emperor Nicholas I, was reorganized into a joint-stock company in 1991 following the collapse of the Soviet Union.

The bank maintained close ties with the Kremlin and throughout the 1990s was the only Russian bank to benefit from a government guarantee on deposits.

Its network of 17,000 branches in green livery meant it was often the only lender available to rural communities in Russia’s vast hinterland.

Sberbank’s national presence and security encouraged Russians to flock to open accounts in the 1990s, even though the interest rates it offered sometimes struggled to keep up with the country’s runaway inflation. It has also become the main bank for Russians to store their retirement savings.

“It is important not only because it retains the bulk of household savings, but Sberbank is very often the only bank capable of providing large lines of credit to large companies due to its size and its capital – no other bank can take the same risk,” said Sergey Aleksashenko, former deputy governor of Russia’s central bank. “Sanctioned Sberbank creates big problems for Russian companies getting credit.”

In 2020, Russia’s central bank sold its 50% stake plus one share in Sberbank to the country’s finance ministry as part of a sweeping plan to boost state revenue to pay for Putin’s pledge to raise the standard of living.

The move also strengthened the finance ministry’s oversight of Sberbank and its powerful chief executive, Herman Gref, who has known Putin since the 1990s.

Gref had been widely praised for embracing Western-style governance and technological change at Sberbank, which was seen as a corrupt dinosaur when he left the cabinet to take charge in 2007.

More recently, Gref oversaw a digital transformation, aiming to transform the lender into “Russian Amazon”. Of the bank’s 102 million customers, 27 million use its banking app daily.

But Gref’s tech ambitions put him on a collision course with state officials, who wanted the bank to focus on paying dividends to fund Putin’s spending promises.

“For him, [sanctions are] a personal tragedy,” said a former director of Sberbank. “He’s been running the bank for 15 years and has accomplished a lot, making it a technology leader and improving its profitability. Now what he built will be pretty much destroyed.

“Sberbank has a big problem, but it won’t die,” said Aleksashenko, the former central banker.

While Sberbank has traditionally been Russia’s retail bank, VTB, which is 92% government-owned, acted as the state’s investment banking arm. Launched in St. Petersburg in 1990, VTB’s initial role was to finance Russia’s post-Soviet domestic economy and connect it to international markets.

“It was the garbage can for everything that didn’t work in Russian companies,” a person close to the bank said. “The government relied on her to take over all these businesses, turn them around and get them back on the market.”

VTB also developed retail banking and in the early 2000s set out to acquire more in Europe, setting up investment banking operations in international financial centers and emerging markets.

Putin moved to incorporate the VTB into Russia’s response to Deutsche Bank after Josef Ackermann, then the German bank’s chief executive, told the Russian leader in 2007 that his country would not be considered a “great nation “until he has a prestigious investment bank.

“VTB’s real job was to try to attract capital to Russia, to help Russian companies raise funds in international markets, and to help the government raise funds for its sovereign bonds,” he said. a former VTB executive. “It was the pipe between Russia onshore and overseas.”

The global expansion has not been without controversy. VTB’s operations in Mozambique have been embroiled in the country’s $2 billion tuna bond scandal, while the bank and its executives have been hit with a series of sanctions since Russia’s annexation of Crimea.

VTB was once forced to apologize after its chief executive, Andrei Kostin, called Boris Johnson, who was foreign minister at the time, a “moron”.

Kostin, who has been sanctioned by the EU and the US, is a former diplomat with no formal banking background. His $56 million superyacht Sea Rhapsody is currently located in the Seychelles, according to yacht data company VesselsValue.

Kostin’s deputy, Denis Bortnikov, was added to the US sanctions list last month. Bortnikov’s father, Alexander, is the head of Russia’s FSB spy service.

The Russian central bank’s initial response to the ruble’s fall – doubling interest rates to 20% – will cause long-term hardship for its banks, as customers will be less inclined to borrow.

But bankers at Sberbank and VTB are confident the CBR will step in to ease a liquidity crunch if customers rush to withdraw their savings.

Bankers are also hoping that the government will help support the fall in their share prices. Shares of Moscow-listed Sberbank more than halved in the days after Russia’s invasion and are expected to fall further when markets eventually reopen and Western investors sell off.

The government “will interfere in the markets, they will buy back public shares, and if the banks’ capital is under pressure, they will recapitalize them,” the former head of Sberbank said. “But one thing they can’t do is keep the money flowing. Soon it will be a major challenge.

Although Sberbank and VTB are listed in Moscow, they are also traded in London through global certificates of deposit, which allow for cross-border investment.

Sberbank’s London listing fell from $15 to just $0.01 in the days before the Russian invasion. The London Stock Exchange has since suspended trading in both banks’ RDAs.

Neither bank responded to requests for comment.

As with Sberbank, VTB is too critical to the Russian economy for the central bank to allow it to fail, Stermer said. But the sanctions will stop its global ambitions.

“If he can’t work with the west, he will have to refocus on the home side,” Stermer added. “Perhaps he is focusing on Asia, as long as his international trade is not completely cut off.”

During VTB’s global expansion in the 2000s, the bank chose a prominent City of London office at 14 Cornhill, right next to the Royal Exchange and Mansion House. The location allowed VTB to fly a huge Russian flag above the Bank of England, in a provocative gesture of financial expansion.

VTB’s London office peaked at more than 500 bankers, with executives poaching staff from rivals in a bid to make the bank a major player in the city.

But after signing a 20-year lease in 2008 on the building that once served as the headquarters of Lloyds Bank, VTB has sublet floors in recent years as staff have been made redundant or moved to Frankfurt. Last month, the London Stock Exchange suspended its membership, preventing it from trading in the market.

On Monday afternoon, the flag poles protruding from the top of 14 Cornhill were bare.