FRANKFURT—Targeting the reserves held by Russia’s central bank is potentially the most powerful weapon in the West’s financial arsenal, and takes aim at the heart of Russia’s financial system. It is a move with few precedents that amplifies other Western sanctions but also carries risks.
The U.S., Europe and Canada pledged Saturday to prevent the Bank of Russia from deploying its $630 billion stockpile of international reserve “in ways that undermine the impact of our sanctions,” they said in a joint statement Saturday. The move directly targets the war chest that President Vladimir Putin has built up in recent years to help insulate Russia’s economy from outside pressures.
The move could be a hammer-blow to Russia’s financial system, limiting the government’s ability to defend the ruble in currency markets, to make overseas purchases and to backstop banks that have been hurt by international sanctions, economists and central-bank officials said.
Russia spent years building up its reserves, converting revenue its oil and gas companies generate through sales abroad into a massive mountain of securities, bank deposits and gold. Foreign reserves are by their nature held abroad, often in government bonds of other nations and at accounts with commercial banks and other nations’ central banks.
The moves announced Saturday would affect close to 40% of Russia’s reserves that were held in North America and Europe as of last June, according to a recent report by Russia’s central bank.
The plan contains gaps and possible loopholes, especially the absence of participation by China, a key Russian trading partner that holds about 14% of its foreign reserves, according to the data. Experts warned that it also violates a tradition of respecting the sovereign immunity of central banks.
“Symbolically speaking, it’s a nuclear bomb in the world of global finance,” said Sony Kapoor, a finance professor and CEO of the Nordic Insitute for Finance, Technology and Sustainability, an Oslo-based think tank.
“There's going to be a huge Russia discount and risk premium for any type of financial transaction whatsoever. It’s going to be macro significant and very painful,” Mr. Kapoor said.
A wildcard is that Russia might already have drawn down a substantial amount of its European reserves in recent months, according to people familiar with the matter.
Germany and France together accounted for roughly 22% of Russia’s international reserves last June, according to Russian central bank data. A French official believes those numbers have changed significantly since then.
In the short term, the move is a significant hit to the viability of the Russian financial system. Longer term, it “opens a whole Pandora’s box” that might accelerate the development of a global financial architecture that is at arm’s length from the West’s ability to disrupt it, Mr. Kapoor said.
There are only a handful of precedents, all targeting much smaller and less connected economies than Russia’s, including Iran, Venezuela and North Korea.
“Normally, without a United Nations Security Council resolution, it’s hard to justify things like this under international law and the principle of sovereign immunity,” Mr. Kapoor said.
The big unknown is China. If Beijing chooses to support Russia, that would substantially diminish the impact of the sanctions, given the scale of China’s foreign reserves and banking sector.
While details of the move have yet to be announced, it is likely to limit Russia’s ability to backstop the nation’s banks with access to foreign currencies, which have recently been weakened by Western sanctions including removal from the Swift messaging system, harming their ability to operate globally.
For foreign investors, the move creates fresh currency and business risks. Investors could have previously relied on the central bank to step in if something were to go wrong in Russia. The ruble would never tank because the central bank wouldn't allow it. That is likely to generate financial outflows.
“It enormously complicates the management of the Russian economy,” said Stefan Gerlach, a former deputy governor of Ireland’s central bank.
“Financial systems need one thing to function, they need trust,” said Mr. Gerlach. “You need to trust your counterparties if you do business. If you suddenly realize that they can't get help from their government if needed, it becomes incredibly riskier to deal with them. You just pulled the carpet from under the financial system.”
The decision is fraught with legal risks. Freezing central-bank assets could create a precedent to target government funds for other reasons.
For example, someone could sue Norway’s $1.3 trillion Oil Fund, which is managed by the central bank and invests proceeds from petroleum sales, over the nation’s impact on climate change, Mr. Kapoor said. Around half of the fund’s assets are under U.S. jurisdiction.
Some governments might respond by moving their reserves out of the West, triggering a bifurcation of the global financial system.
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