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A Banking Haven No More

Latvia’s time as a financial bridge between East and West has come to an end.

by Martin Ehl 6 May 2019

Latvia has twice been pushed to the edge of political and economic ruin over the past decade, when the small Baltic country's thriving banking sector played host to attractive but dangerous money of dubious origin. Now push is coming to shove, and international traffic across this former banking “bridge” may stop completely.

 

The first time, the catastrophe was the collapse of the country's second-biggest local bank, Parex. This occurred in the autumn of 2008, amid the wider financial crisis, and inflicted the most severe crisis experienced by any of the new EU and NATO member states. The government had to cover Parex's debts with public money, and Latvia was plunged into a deep recession.

 

A decade later – with Latvia now in the eurozone – panic was sparked in Riga when the U.S. financial crime agency FinCen reported in February 2018 that Latvia's third-biggest bank, ABLV, was helping the North Korean regime to launder money.

 

This time around, there were measures in place to avoid systemic banking disruption. ABLV was stripped of its license and is being liquidated. But the sense of alarm has not dissipated: if anything, the shockwaves are getting stronger. In the face of strong anti-money laundering pressure from the United States, Latvian politicians are now pushing even further with reforms than they did after 2008.

 

Five days after the FinCen report, Ilmars Rimsevics, the powerful governor of the National Bank of Latvia – and thus a member of the European Central Bank – was detained on accusations of corruption.

 

In recent interviews with the Czech business daily Hospodarske Noviny and TOL, the head of the Latvian anti-corruption agency KNAB, Jekabs Straume, and Foreign Minister Edgars Rinkevics both rejected the idea that the central bank governor’s case was directly tied to the case of ABLV.

 

However, both officials acknowledged, independently of one another, that the days when Latvia was called “a little Switzerland” because of its banking industry are over.

 

Latvia's banking tradition was once built on being the bridge between East and West. There were many potential clients in the former Soviet republics, and elsewhere, who needed to transfer money of “different origin” to the EU, and little Latvia’s mostly private banks offered their assistance.

 

They were not the only ones providing a helping hand. Last year, it was revealed that Estonian and Latvian branches of Western banks, such as Danske Bank and Swedbank, were involved in what turned out to be outright money laundering. That scandal is still playing out in Scandinavia and all over Europe.

 

In Latvia, the increased pace and urgency in banking reform began under the previous government after the FinCen report, and has continued under the new coalition, which was formed after parliamentary elections in October 2018.

 

“Reform of banking oversight is our priority number one,” Rinkevics said.

 

This has already borne fruit, with massive movements of money. “We have seen the outflow of about 5 to 6 billion euro ($5.57-6.69 billion) last year,” said Peteris Putnins, the head of Latvian banking regulator FCNC, in an interview at his office in Riga's Old Town.

 

By the end of 2018, the proportion of banks' so-called non-resident clients – those not formally Latvian citizens or entities – dropped dramatically, from above 50 percent to less than 25 percent. According to FCNC figures, 91 percent of the Latvian banking sector's clients are now resident in Latvia or the EU, and only the remaining 9 percent are “third-country” clients.

 

Yet this might have been one of Putnins' last interviews in office, because a new law, whose adoption by the Latvian parliament is expected in the next few weeks, will change the way in which the board of FCNC is named. Putnins – criticized for his lack of action over recent years – is in danger of dismissal.

 

The FCNC head has, however, hit back, saying that politicians want to reduce the regulator's independence, by giving parliament the right to appoint all five of its board members. Currently, parliament names only the top two posts, with the remaining three chosen by the head of the FCNC – meaning Putnins.

 

What does all of this mean for the country's formerly powerful banking sector? Putnins said the regulators expected “two to three years of negotiations” between the regulator and banks oriented on non-residents. In a clear indication that this would mean the banks moving away from non-EU clients, Putnins stressed: “The banking industry should adapt to the local economy.”

 

Meanwhile, Latvian experts and politicians nervously await a report by the Council of Europe monitoring body Moneyval, which assesses countries' ability to counter money laundering. In advance of that report, no Latvian source – whether politician, banker, or even independent expert – was willing to speculate about whether the latest reforms are sufficient, possibly through fear of attracting regulators’ attention.

 

Local banking players do not want to abandon contact with the financial world completely, but are keen to cut off direct contact with clients whose money comes from dubious sources.

 

And the governor of the National Bank? Rimsevics's suspension from office was repealed after a decision by the European Court of Justice, although merely on administrative grounds. He has since been charged in a second bribery case. According to Straume, from the anti-corruption agency, both cases are connected with banks in poor financial condition trying to influence the central bank’s judgement on them.

 

“During the last year, there has been a dramatic change,” he said. “All organizations involved in countering money laundering have been strengthened. At this moment, we are very close to the point when we can say the banking sector is cleaner than ever before.” His agency is expecting a 20-25 percent increase in funding and staff over the next 12 months.

 

In the eyes of bankers, this is the end of a quarter century of Riga's position as a banking bridge between East and West. It could also mark a dramatic shift in the fight against local corruption. Yet beyond these known milestones, the road ahead is shrouded in mist.

Martin Ehl is chief analyst at Hospodarske Noviny (HN), a Czech business daily. 
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