The US is turning to a powerful yet risky tool in authorising secondary sanctions against banks as it escalates efforts to deny Russia the money it needs to wage war in Ukraine.

In a statement on Friday (Dec 22) just before the Christmas holiday, the US Treasury Department announced that it would use sanctions against banks that facilitate deals in which Russia procures semiconductors, ball bearings and other equipment necessary for its war machine – even if they’re not aware they’re doing so. 

The move significantly expands the US financial battle against President Vladimir Putin, whose forces show little sign of relenting in Ukraine’s east. Since the Russian invasion nearly two years ago, the US imposed hundreds of sanctions on companies and individuals, but until now it had stopped short of penalising banks and financial institutions for working with sanctioned entities.

Imposing secondary sanctions is a controversial decision because the potential impact is hard to predict and carries the risk of unintended consequences. Wary of violating rules, banks might abandon entire sectors even if they’re not sanctioned. And even some allied countries consider secondary sanctions to be an overreach of US authority.

“This is a huge move, but I think Treasury’s going to have to be very cautious and careful about how it uses this tool because of potential unintended consequences,” said Kim Donovan, a former Treasury official now at the Atlantic Council. “If you sanction a foreign financial institution or fine a US bank for doing business with them, that can have a lot of ripple effects.”

President Joe Biden’s new executive order on Friday also comes at an urgent time for the war, with Republican lawmakers in Congress so far refusing to provide more than US$60 billion in new military assistance for Ukraine.

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The US may also have felt it has no choice. Despite the imposition of one of the most crippling sanctions regimes in history, Russia has pressed ahead with its war, finding plenty of willing partners in countries that are outright adversaries of the US, such as Iran, China and North Korea.

Some of Russia’s success has had to do with the size of its economy and the fact that it produces oil that the rest of the world needs. A price cap on that oil implemented by the US and its allies in the Group of Seven nations has resulted in much of that trade moving from Europe to India and China.

The US has ramped up enforcement of that price cap in recent months, sanctioning on Wednesday two Hong-Kong based oil traders and a UAE-based shipping management company with ties to the Russian government.

But there are still many companies and countries that have also been willing to trade with Russian firms, often indirectly, as part of a broader strategy of refusing to take sides in the war or enforce the US and European sanctions.

Now the US is telling them to make a choice: either do business with Russia, or keep your access to the global financial system.

“All of these companies still have to use the financial system,” Deputy Treasury Secretary Wally Adeyemo said in an interview on CNBC on Friday. “What this executive order gives us the ability to do is to target smaller institutions that may be unwilling to or wittingly trying to get around our sanctions.”

The US is also using Friday’s move to close other loopholes that had given Russia access to cash. The order will let the US ban products that originated in Russia but were transformed outside its borders. That’s aimed chiefly at diamonds, which Russia has shipped to countries such as India for processing before they go to jewelers in the US.

There’s good precedent for the latest move. In the 2010s, as part of efforts to rein in Iran’s nuclear programme, the US imposed crippling sanctions on the country and threatened secondary sanctions against anyone who did business with it. Policymakers point to the sanctions regime as a key reason Iran’s leaders eventually came to the table and agreed to limits on their nuclear ambitions in 2015.

The challenge is that Russia’s economy is much bigger than Iran’s and it ships a lot more oil around the world. Squeezing the Russian economy further could send shockwaves around the world and imperil President Joe Biden’s so-far successful effort to keep the economy chugging on the cusp of an election year.

“If your goal is to really hurt Russia’s economy, there’s no alternative than going after it’s oil revenues,” said Eddie Fishman, a senior research scholar at Columbia University’s Center for Global Energy Policy. “And I still don’t see the political will in the US or anywhere else to truly aggressively target Russia’s oil revenues.” BLOOMBERG