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Latvia has made itself into an important transit hub between Russia and other former Soviet republics and the West by capitalizing on its location, Russian language and deep understanding of the “Soviet mentality.”
“We are closer than Switzerland,” is how one of the country’s larger commercial banks put it in a 1990’s slogan.
Latvia is the financial center of the Baltic States and houses 32 banks, 10 of them branches of foreign banks. Foreign deposits represented 41 percent of all deposits in the banking system in mid-2011, according to the Latvian Association of Commercial Banks.
The Latvian banking system began emerging in the early 1990s, after the collapse of the Soviet Union when each former republic introduced its own currency and set up its own settlement system.
A few businessmen in Latvia got very rich very quickly by facilitating currency exchanges and accepting deposits on the promise of enormously high interest rates. The government accommodatingly made no particular requirements about who could establish or own banks. Soon more than 50 banks popped up during the first half of the 1990s. Some were linked to politicians, others were small banks owned by known criminals. Olimpija Bank, for instance, was owned by Vladimirs Ļeskovs who had business relations with members of the “Pārdaugava” organized crime group and Russian organized crime.
Oversight of the banking sector initially fell to the Bank of Latvia. In 1994, it closed down the TOP Bank and the People’s Bank for failing to satisfy obligations toward clients. This set off a banking crisis that ultimately bankrupted19 banks.
The first serious wave of the crisis occurred in 1995, when the largest bank in Latvia, the organized crime connected Banka Baltija, went under. Thousands of people including pensioners, homemakers, and working people queued outside the bank’s locked doors to demand their money. The bank had bet on a devaluation of the national currency, the lats, and it had set up a classic pyramid scheme with promises of 90 percent return on deposits. The first sign of the bank’s imminent collapse coincided with a parliamentary election campaign. Politicians dared not reveal what was about to happen and, indeed, Prime Minister Māris Gailis appeared on television a few days before the election to say that the bank was stable and in good shape. After the voting, Banka Baltija collapsed and depositors lost all their money.
Owners and managers of Banka Baltija were tried for emptying the bank’s coffers, but no money was recovered. Banka Baltija was the first and most vivid example of the politicization of the banking system. The bank owners were influential enough to draw top government officials to receptions. Loans to local governments passed through Banka Baltija, as did an international loan from the G 24.
The owners expected that the state would rescue and protect the bank along with its sprawling structure of branches and depositors. But at the first sign of trouble, bank managers allegedly alerted prominent persons so that they could withdraw their money before the run on the bank.
What was ignored by bank regulators was the links between bank owner Aleksandrs Lavents and organized crime.
After the Banka Baltija crisis, stricter banking rules were implemented. The Latvian Financial Intelligence Unit, which targets money laundering, was established in 1998. It remains a small agency, with just 16 employees in 2010.
Also in 1998, a financial crisis in Russia took a toll on Latvia, and the operations of the Rīga Commerce Bank were halted. It was later rescued with financing from the European Bank for Reconstruction and Development (EBRD) and other international sources. The pivotal year of 1998 is when foreign capital began to flow into Latvia’s banks. The largest banks from Scandinavia entered the market and became key players – SEB (Sweden), Swedbank (Sweden), DnB ORD (Norway), Nordea (Finland), and Norvik (Iceland). The Scandinavian banks took over the lending and account servicing market. Only Parex Bank, then the largest and most influential national bank, could compete.
The Scandinavian banks led to a cleaning up of Latvia’s financial sector, but the main push to apply new regulations in the banking system came in 2005, when the United States threatened to close its accounts in Latvian banks because of suspicions of money laundering. In April 2005, Americans announced concerns about Multibank Bank and VEF Bank under the auspices of the US Patriot Act. Thirteen of 23 Latvian banks at that time were under intensified supervision by the Finance and Capital Markets Commission because of deficits in their anti-money laundering systems.
The VEF Bank was one of the smallest in Latvia, with approximately $80 million in assets and 87 employees in 2004. In April 2005, the US Financial Crimes Enforcement Network (FinCEN) announced their concerns that VEF was facilitating or promoting money laundering. Specifically, the VEF Bank was declared to be an important banking resource for illicit shell companies and financial fraudsters, allowing criminals to pursue illegal financial activities.
These findings were published in proposed rules that would ban US financial institutions from opening any direct or indirect correspondent accounts in the United States for VEF.
Currently more than 30 legislative acts apply to financial institutions in Latvia. The most important is a money laundering law that took effect in June 1998. It was replaced a decade later by a new law on money laundering and terrorism financing.
Latvian banks now must report to the Office for the Prevention of Money Laundering (FIU) any suspicious activities and unusual transactions, including large cash transactions. The Cabinet of Ministers has defined a list of indicators for unusual transactions – a cash transaction in the amount of LVL 40,000 (about US$76,000) or more, as well as a withdrawal of LVL 40,000 (about US$76,000) or more in cash via credit cards or other payment cards within the period of one month.
Indicators of suspicious transactions were not well defined, but the law does require banks to conduct due diligence on clients and to report suspicions to the FIU at once. Local and foreign law enforcement bodies say this requirement is too open to interpretation.
In 2007, the International Monetary Fund declared that the vast majority of suspicious transaction reports filed with the FIU related to the established list of indicators of unusual transactions. The IMF concluded that the financial institutions were perhaps too heavily reliant on the provided lists, thus not paying sufficient attention to circumstances these did not address. This, said the agency, meant that the FIU received a significant number of reports with little analytical value.
Banks face other requirements. They are not allowed to open accounts without conducting due diligence on customers or obtaining proper identification from residents and non-residents alike. When opening accounts for legal entities, banks must collect information on their incorporation and registration.
When it comes to identifying the beneficial owners, banks are obliged under Know Your Customer (KYC) procedures to identify them for all clients and for all clients acting on behalf of third persons. In practice, this means that high-risk customers, including non-residents, are obliged to sign a declaration in which they identify real owners.
A KPMG auditing firm review in all three Baltic States in 2011 showed that most banks only obtained missing KYC documentation when an existing customer engaged in new business transactions with the bank.
In addition to government requirements, Baltic banks have used various tools of their own to monitor transactions, though questions exist about their efficiency. The KPMG study showed that only one-third of Baltic banks have purchased IT monitoring systems from external providers – ones which produce more sophisticated reports than simple exception reporting. Two-thirds rely on internally developed systems. This can be attributed to the comparatively small size of banks in the Baltic States, but it is also true that banks in the region are known to engage in large volumes of transactions. They also have many non-resident customers with complex structures that require more attention than an internally developed system can provide, KPMG concluded.
Two major institutions in Latvia are responsible for prevention of money laundering. The Office for the Prevention of Money Laundering (FIU), was established in 1998 and it analyses information about unusual or suspicious transactions for pre-trial investigatory institutions and courts. The FIU also can suspend transactions at the request of authorized institutions in other countries.
According to the FIU, banks reported 16,407 unusual or suspicious transactions in 2010. In addition, the agency issued 48 instructions to freeze accounts totalling US$2.78 million. In 2009, US$10.4 million in assets were frozen. Criminals are learning from their mistakes, and they no longer engage in major transactions which draw attention.
At the same time, however, law enforcement officials in Latvia complain that the FIU is insufficient because it has no investigatory authority of its own. It takes time, sometimes as long as six months, for the agency to forward data to other law enforcement institutions. That is too late to engage in an effective investigation or enforcement action.
Although the FIU mostly focuses on crimes committed inside Latvia, it responded to 227 requests from foreign agencies in 2010.
The Latvian Finance and Capital Markets Commission (FCMC) is the supervisory authority for banks in the country, and it regulates and monitors the financial markets. If violations of law are identified, the FCMC can restrict the opening of new accounts or replace management of a financial company. The FCMC is also obliged to report to the FIU illegal actions it discovers during bank audits. Sanctions for non-compliance can amount to as much as LVL 100,000 (around US$200,000).
However, banks in Latvia still frequently appear in cases related to international money laundering. The fines applied to violations of the law have been small. In 2010, the FCMC fined three banks – US$20,000 in one case and US$50,000 apiece for the other two. The agency does not disclose the violations or the names of the banks fined. In 2009, it fined two banks US$20,000 and US$100,000 respectively.
In 2008, global financial woes hit Parex Bank, the largest locally and independently owned bank in the Baltic states, so severely that the government, fearing repercussions on the entire economy, took it over for the symbolic sum of LVL 2 (US$4). Parex was forced to seek state protection after clients panicked and withdrew US$120 million in November 2008 alone. Many of its clients were national and local government institutions, including the capital city of Rīga. After rescuing Parex, Latvia was forced to seek a €7.5 billion bailout from a group led by the European Commission and the International Monetary Fund.
Before the crisis, Parex was the second largest bank in Latvia in terms of assets – €4.9 billion in December 2008 – and a market share of 18 percent of deposits and 12 percent of loans in the Latvian market.
Parex was established in 1992 by two former leaders of the Komsomol youth organization in the Soviet Union, Valerijs Kargins and Viktors Krasovickis. The bank survived similar crises in 1993, 1995 and 1998, not least because of tight links with politicians in the ruling parties. Parex was also a major player in the sector of non-residential clients.
In 2005, the US placed Latvia on a list of countries alleged to be tax havens, and Parex was the first bank to hire an American lobbying company (Dutko Worldwide) to seek the removal of Latvia from the list followed later by VEF Bank and the Trust Commerce Bank. To spare expenses five Latvian banks joined together in 2007 to set up the Latvian-American Financial Forum. It was directed by the Latvian ambassador to the US and hired lobbyists jointly.
All five members of the forum focused on non-residential clients – the ABLV Bank, the Trust Commerce Bank, the Regional Investment Bank, PrivatBank, and the Baltic International Bank. Parex chose not to join because of disagreements with other banks.
The Latvian-American Financial Forum was recently replaced by the Latvian Association of Private Banks. One of its stated goals is “to strengthen the professional reputation of private banks.”
After the government took over, it transferred Parex operations in 2010 to the newly established Citadele Bank. The remnants of Parex were turned into a resolution bank. Its shareholders are the Latvian state (75 percent), and the EBRD (25 percent plus one voting share).
Following the collapse of Parex, Scandinavian banks reduced their operations in Latvia. Lending ground to a halt. Banks became more involved in real estate management, because many borrowers hit by the crisis could not repay their loans, and so banks took over their properties.
And yet the banking sector never experiences a vacuum. Russian capital appears to be flowing into Latvia. Latvijas Krājbanka, owned by Snoras and the Konvers Grup company of the Russian billionaire Vladimir Antonov and his family is one example. The Latvian Business Bank, owned by Bank Moskvy, and the LTB Bank, owned by the MDM Bank are others.
In 2008, the Multibanka Bank was replaced by the SMP Bank, which is owned by the Rothenberg brothers. Antonov’s Snoras Bank opened a branch in Rīga this year, as did the Eesti Krediidipank (a subsidiary of Bank Moskvy) and the Rigensis Bank (owned by Oleg Tsiplakov from St Petersburg). GE Money Bank was sold to the Otrkytie financial corporation. The FCMC has not licensed it so far.