RIGA, Latvia - When Latvia adopts the euro Wednesday, it will bring with it a banking sector that is swelling with suspicious money from Russia and the east - just as the currency bloc is trying to clamp down on such havens.
Just nine months ago, the eurozone rescued Cyprus, a similarly tiny member state that also specialized in attracting huge deposits from Russia. Since then, eurozone leaders have vowed to crack down on financial sanctuaries and improve transparency.
But as the 18th member of the eurozone, Latvia is likely to see a greater - not smaller - influx of dirty money as the country will be viewed as safer than other former Soviet states while financial oversight remains loose.
“Immediately after Latvia joins the eurozone, I imagine we’re going to see an actual spike in dubious money flowing in,” said Mark Galeotti, a professor at New York University who researches organized crime in the former Soviet Union.
For years, Latvia’s political and financial leaders had hoped to create a mini-Switzerland in Eastern Europe - a place where capital in unstable countries such as Russia or Kazakhstan could either be parked for a while or channel its way further west to banking meccas such as Zurich or London.
After a slight dip during Latvia’s financial crisis in 2008-2010, the amount of nonresident bank deposits has risen rapidly over the past two years ahead of the country’s entry into the eurozone.
“The issue with Latvia is that you have a pretty permissible political environment, and you have the massive and quite efficient infrastructure for managing these funds from the East. The question is, why wouldn’t you want to go to Latvia?” said Galeotti.
Latvia has 20 domestically registered banks, or one for every 100,000 residents - an extremely high ratio. Of these, about 13 are considered “boutique banks” that rely almost exclusively on foreign funds, mainly from volatile countries of the former Soviet Union. Rather than lend to businesses and consumers, these tiny financial institutions primarily serve as safe havens or money transfer operations. They tend to keep their money in liquid assets so it can quickly be moved.
Some of the money is dirty. This year, Latvia’s bank regulator slapped a $200,000 fine on a bank for failing to exercise sufficient internal controls with money connected to the so-called Magnitsky case.
Sergei Magnitsky was a Russian lawyer who worked for Hermitage Capital, an investment fund whose chief executive accused Russian police officials of stealing $230 million in tax rebates after illegally seizing Hermitage subsidiaries. In 2008 Magnitsky, at the age of 37, died in prison of pancreatitis, purportedly after being beaten and denied medical treatment.
Hermitage Capital claimed that tens of millions of dollars of the stolen money passed through Latvia.
Claiming confidentiality and a risk of destabilizing the industry, Latvia’s regulator refused to “name and shame” the bank connected to the case. This refusal, as well as the small size of the fine, triggered criticism and renewed doubts about the regulator’s integrity.
“The regulators don’t have teeth,” said Galeotti. They maintain “a kind of culture that emerged in Latvia in the late 1990s … which was ultimately ‘Latvia desperately needs business,’ and therefore the role of the regulator is not to impede business,” he said.
Nonresident bank deposits comprise nearly half of all deposits, which is unusual, and they are on the rise. In the first quarter of 2013, nonresident deposits soared 17.7 percent compared with the same period in 2012 - clear evidence that Latvia’s attractiveness as a safe haven is not relenting. The economy has been the fastest-growing in the EU for the past three years.
“Latvia has historically had a large banking sector,has extremely strict data privacy laws, speaks Russian and ‘gets’ the post-Soviet mentality,” said Tom Wallace, an analyst at C4ADS, a Washington, D.C.-based firm that specializes in data analysis and security.
Latvia’s banks face scrutiny in a eurozone-wide review by the European Central Bank, which is trying to find weak spots in the financial sector to improve transparency and confidence.
The good news for the eurozone is that Latvia’s banking system is not too big compared with its economy. That means the country is less likely to need a bailout from its new eurozone partners to save its banks, should they run into trouble, as happened with Cyprus. As of Sept. 30, the banks held nearly $30 billion in assets, or about 120 percent of gross domestic product, far less than the average 320 percent in the eurozone in 2011.
Latvia’s regulator says it has introduced a number of controls aimed at anti-money laundering, counter-terrorist financing, and preventing excessively large sums from entering the banking system. Experts agree that the regulator has acknowledged the risks of dirty money and is addressing them, even if slowly.
But Latvian bankers say that pinpointing dirty money is not that easy.
“In certain cases, simple filters do work and help to avoid the acceptance of rogue players,” said Arvids Sipols, who has worked 16 years in Latvian banks and is now on the board of Nord Capital Markets, a Riga-based asset management firm. “In other cases it will not suffice, and it is not a banker’s job to become an international detective.”
Business, Pages 21 on 12/31/2013