Yellen warns German banks to boost compliance with US sanctions on Russia

By David Lawder

FRANKFURT (Reuters) -U.S. Treasury Secretary Janet Yellen urged German bank executives on Tuesday to step up efforts to comply with sanctions against Russia and shut down efforts to circumvent them to avoid potential penalties themselves that would cut off dollar access.

Yellen said at the start of a meeting with bankers that the Treasury's new authority to hit banks with secondary sanctions if they aid Russian military-related transactions had helped to frustrate Russia's efforts to procure goods needed for its war in Ukraine, but more work was needed.

"Russia continues to procure sensitive goods and to expand its ability to domestically manufacture these goods. We must remain vigilant and be more ambitious," Yellen said.

"I urge all institutions here to take heightened compliance measures and to increase your focus on Russian evasion attempts," Yellen said in prepared remarks for the meeting in Frankfurt.

In an unusually direct warning, she told the executives to police sanctions compliance among their banks' foreign branches and subsidiaries and reach out to foreign correspondent banking customers to do the same, especially in high-risk jurisdictions.

"Russia is desperate to obtain critical goods from advanced economies like Germany and the United States," Yellen said. "We must remain vigilant to prevent the Kremlin’s ability to supply its defense industrial base, and to access our financial systems to do so."

She later cautioned, however, that the Treasury will be "judicious" in applying any secondary sanction on banks and that the executives she had met on Tuesday had expressed a "very strong commitment" to doing their part.

RAIFFEISEN WARNING

Yellen's warning comes shortly after the U.S. Treasury successfully pressed Austria's Raiffeisen Bank, the biggest Western bank in Russia, to ditch a deal involving a Russian tycoon.

Earlier this month, Raiffeisen Bank International (RBI) dropped a bid for a 1.5 billion euro ($1.6 billion) industrial stake linked to Russian tycoon Oleg Deripaska after intense U.S. pressure.

The deal's collapse was a fresh setback for the lender, which faces criticism for its ties to Moscow more than two years since Russia's invasion of Ukraine. The pressure also underscored Washington's willingness to take European banks to task over their Russia ties.

Raiffeisen was warned by the U.S. Treasury in writing that its access to the U.S. financial system could be curbed because of its Russia dealings, a person who has seen this correspondence told Reuters.

On May 6, Deputy Treasury Secretary Wally Adeyemo sent a letter to RBI, expressing concern about RBI's presence in Russia as well as a $1.5 billion deal.

RBI's announcement followed weeks of pressure over its plan to buy a stake in construction group Strabag, a move designed to unlock bank funds frozen in Russia.

MEANINGFUL CONSTRAINTS

And a senior U.S. Treasury official acknowledged that Western banks face "meaningful constraints" in exiting Russia, but they should not be seeking to expand their Russian businesses as Raiffeisen has.

The official added that Austrian regulators should take a more aggressive posture to avoid reputational risks for a systemic institution.

"The mere fact of the secondary sanctions existing already gets us to our goals in some ways," the official said on condition of anonymity.

Spokespersons for Germany's two largest banks, Deutsche Bank and Commerzbank, both said they had significantly reduced their business in Russia and were complying with the sanctions.

Yellen said the most concerning Russian sanctions evasion activity was coming through China, the United Arab Emirates and Turkey. She added that the Treasury "is working to disrupt evasion wherever we see it, from Central Asia to the Caucasus and throughout Europe."

Yellen, who also gave remarks on the U.S.-European alliance in Frankfurt before attending a meeting of G7 finance ministers in Italy this week, said she sees the global economy outperforming expectations with risks broadly balanced and financial conditions easing since last year's banking turmoil.

"We also remain vigilant to potential vulnerabilities, including elevated levels of corporate debt, leverage and liquidity mismatches in the non-bank sector, and strains in commercial real estate markets," Yellen added.

(Reporting by David Lawder; Additional reporting by John O'Donnell and Francesco Canepa; Editing by Andrew Heavens, Emelia Sithole-Matarise, Chizu Nomiyama, William Maclean)