Neighboring Russia, and Under Its Sanctions’ Shadow Too
November 13, 2014 By Kira Zalan
  

Whatever the effectiveness of sanctions meant to sway Russia’s involvement in Ukraine, one thing is certain: they’ve worsened the country’s capital flight problem. By year’s end, approximately $128 billion will have moved abroad, up from $63 billion in 2013, according to Russia’s central bank. The European Central Bank in May cited a figure four times Moscow’s numbers.

 

But tracing where those funds are winding up and how they got there is difficult, according to financial crime experts. For countries with long-held financial and political ties to Russia, such opacity is only deepening suspicions that their financial institutions may be conduits for sanctions dodgers and money launderers.

 

Take Latvia, a former Soviet republic that earlier this year became the latest nation to adopt the euro. As part of an effort to align its banking sector with international standards, the Baltic country in 2008 passed an anti-money laundering law and established a financial intelligence unit—steps recognized by the Council of Europe’s Moneyval in 2012.

 

Latvia’s financial markets regulator hasn’t registered a subsequent increase in Russian capital deposits since March, the beginning of western sanctions over Russia’s involvement in Crimea.

 

Official statistics notwithstanding, “there’s a big industry in moving Russian money through Latvia,” said Josh Simmons, policy counsel at Global Financial Integrity, a Washington, D.C.-based advocacy group.

 

With Russian clients, “it’s difficult to know a lot of the time where the money is actually coming from,” said Simmons. “You don’t know if it’s proceeds of corruption, a state-owned entity or an individual that’s been sanctioned by the U.S.”

 

Under U.S. and EU sanctions, banks must freeze the assets of dozens of Russian companies and individuals and sharply limit the maturation windows on credit extended to certain businesses. The restrictions have forced banks to decipher hundreds of corporate arrangements worldwide to determine their exposure to monetary penalties.

 

‘Quite a temptation’

 

With a population of two million and a complex history with Moscow, Latvia has leaned toward the West since gaining its independence in 1991. That hasn’t stopped an influx of suspicious Russian funds, however.

 

An investigation by the nonprofit Organized Crime and Corruption Reporting Project in August exposed a scheme in which 19 Russian banks allegedly used fake debts and courts to transfer $20 billion through Moldova’s Moldindconbank to Latvia’s Trasta Kommercbanka AS between 2010 and 2014.

 

The exposure of Latvian banks to criminal exploits is exacerbated by the financial sector’s reliance on non-resident clients. Nearly half of all deposits in the country’s banks belong to foreign clients, according to national statistics.

 

“One of the biggest challenges in general is the presence of money of foreign origin in banks,” an official in Latvia’s Financial and Capital Markets Commission (FCMC) told ACAMS moneylaundering.com via e-mail. To better monitor foreign money, the regulator has imposed stricter anti-money laundering (AML) duties on banks with high shares of non-residential accounts, the person said.

 

“For so long, there’s been a boutique banking sector: customer oriented, whatever you want done, we’ll find a way to do it,” said Mark Galeotti, a professor at New York University. “It’s difficult [for regulators] to say, in effect, sometimes you’ll have to turn away business, particularly when the banking sector faces a lot of competition and livelihood depends on turnover.”

 

Galeotti, who has researched money flows into Latvia, said there is anecdotal evidence that Russians are willing to pay as much as double in percentage fees to have their money laundered.

 

“This is quite a temptation for Latvian bankers,” he said.

“Risks are increasing, but so are opportunities in the short-term.”

 

One day before the imposition in March of U.S. sanctions over violence in Ukraine, the chief executive officer of Latvia’s PrivatBank described plans to grow the banks non-resident deposits, particularly from clients in Russia, Ukraine, Kazakhstan and Azerbaijan—“countries in which businesses are interested in EU banks,” according to Latvian news agency LETA.

 

Small sector, big perks

 

Although the size of Latvia’s banking industry remains modest when compared with offshore hubs like Cyprus and Malta, the country is nevertheless a regional financial center, according to the country’s regulator.

 

That’s because Latvian banks have carved a niche by “dealing with short-term incoming cash flows,” said Kristaps Zakulis, FCMC chairman, in a statement. The specialization differentiates Latvia from historical financial sectors, such as Switzerland and London, which focus more on attracting long-term deposits from non-residents, according Zakulis.

 

With Scandinavian-owned Swedvank, SEC and Nordea dominating the domestic market, Latvian boutique banks have had to cater to Russian-speaking clientele, according to Galeotti and Andrew Bowen, a Boston College Ph.D. candidate working with Galeotti.

 

Rietumu Banka, which in August was the subject of a FCMC enforcement action for inadequate customer controls, advertises 5-year residence permits for foreign investors who deposit more than 300,000 euros in 5-year-term deposits or bonds—“the fastest and easiest way to the residence permit.”

 

The permits, which can also be obtained by investing 72,000 euros in real estate or 35,000 euros in a business, come with an EU national ID card and a guarantee of free movement within 25 countries of Europe’s Schengen Area.

 

With the exception of Hungary, Latvia’s permit thresholds are lower than any other EU country, including Spain, Greece and Portugal. But while Hungary’s permanent residence program has “reportedly attracted little interest,” over 7,000 people—75 percent of whom are Russian—had been granted permits as of 2013, according to an August 2013 story by The Wall Street Journal.

 

“Cyprus is still under heavy surveillance while Latvia is still an integral point for getting capital out of Russia,” said Bowen, adding that there has been talk recently of repealing the lax residency visa system. “They’re trying to be more careful,” likely as a result of pressure from other European economies, he said.

 

Checkered past

 

If Latvia has made progress in policing its financial sector, it has done so following decades of banking troubles.

 

Immediately after the fall of the Soviet Union, in the early 1990s, the Baltic nation adopted a posture on financial regulation that was “extremely liberal,” said Anders Aslund, a senior fellow at the Peterson Institute. “They simply didn’t understand what they were doing.”

 

Parex Banka, established in 1992, was “a money laundering bank from the outset,” that would “exchange all currencies and ask no questions,” said Aslund. Parex became the second largest bank in Latvia and was subsequently faulted for facilitating money laundering and corruption.

 

In 2005, the U.S. Treasury Department designated Multibanka and VEF Bank as institutions of “primary money laundering concern” under Sec. 311 of the Patriot Act.

 

Two years later, six Latvian banks were among the financial institutions implicated in the so-called “Magnitsky Affair,” in which attorney Sergei Magnitsky allegedly uncovered evidence of a $230 million Russian tax fraud. The perpetrators purportedly funneled $63 million through Latvia’s banking system.

 

Following a probe into the allegations, FCMC fined one unnamed bank approximately $200,000, the maximum monetary penalty the regulator can impose for poor internal controls. Latvian media reported that $365 million may have been laundered through an account at Trasta Komrcbanka, $6.2 million of which may have had links to fraud scheme.

 

The Latvian bank has denied the allegations.

 

Other scandals have linked Latvian banks to money laundered by Mexican drug cartels and deposed Ukrainian officials.

 

Following compliance troubles at home, at least one U.S. bank—JPMorgan Chase— decided earlier this year to end its dollar-clearing transfers for Latvian lenders, officials confirmed. Commerzbank and Deutsche Bank are still providing the services for Latvian banks, according to the bank Web sites.

 

To address concerns, Latvia intends to impose tougher AML rules on banks “to sharpen the combat of potential money laundering through the Latvian financial sector,” officials said in an e-mail.

 

But more rules may not be enough, according to Galeotti.

“To be honest, there is a need for people to get caught and tried and put in prison to get people to realize that the balance between risk and opportunity has shifted,” he said.