Latvia's Post-Soviet Money Pipeline Is Closing

(Bloomberg View) -- The Latvian central bank has barred its governor, Ilmars Rimsevics, from working on its premises. Despite Rimsevics's determination to resist multiple accusations of bribery, his career, which culminated in a seat on the European Central Bank's Governing Council, appears to be ending. It is, however, just a symptom of a more significant fall -- that of what's known as "Latvian-type correspondent banking," a system which has facilitated the flight of tens of billions of dollars from the former Soviet Union to offshore jurisdictions.

Since it became independent in 1990, tiny Latvia has been pragmatic about making money off its proximity -- cultural more importantly than geographic -- to vast, messy, corrupt countries such as Russia, Ukraine and Kazakhstan. In the early 1990s, it became known as a post-Soviet Switzerland for its extremely flexible and secretive banking industry. It was, however, in a way the opposite of the Swiss one. The Latvian banks that specialized in servicing non-residents were always a group apart from those that worked with locals, and didn't focus on attracting deposits. Rather, through a strong network of correspondent relationships with Western banks, they served as a pipeline for post-Soviet money to safer havens, a pipeline as capacious as the ones that have pumped Russian gas to Europe. In 2013, when the IMF reviewed the system, it found that a quarter of the non-resident banks' assets were parked with foreign banks with which they had correspondent relationships. Switzerland, in other words, was not so much a model as a destination.

"The Latvian banks mainly provide financial logistics services to non-resident customers, i.e. they are dealing with short-term incoming cash flows," Kristaps Zakulis, head of Latvia's Financial and Capital Market Commission (FCMC), explained in 2012. "This could be regarded as export of financial services that improves also the payment balance sheet in Latvia."

Russian, Ukrainian and other post-Soviet businesses needed to get money out of their countries as well as to evade taxes. One way to cut the tax bill is to use a fictitious foreign buyer, with a legitimate foreign bank account, for the first cross-border sale. Latvian non-resident banks helped create such "trading partners" controlled by the tax evaders themselves. Organizations linked to the banks' executives and founders "minted" shell companies in various jurisdictions. The biggest network of such companies ever discovered by investigative reporters was reportedly set up by a team from Parex Bank, once the leader of Latvian non-resident banking, nationalized in 2008 and then wound down. These firms have been involved in a multitude of shenanigans -- from the murky business dealings of Donald Trump's former campaign manager Paul Manafort to the embezzlement of $5 billion from the Kazakhstan bank BTA.

This was great business for Latvia. According to FCMC, the non-resident banking sector -- which was about as big by assets as the domestic one -- has been contributing between 0.8 percent and 1.5 percent of the country's GDP. One can only speculate as to why the other Baltic countries, Estonia and Lithuania, didn't develop similar industries, at least not on the same scale; the likely reason is that of the three countries, Latvia has the biggest share of Russian speakers in its population. They are important in politics (the "Russian" party wins one election after another but is kept out of governing coalitions) and in business, so Latvia is the least leery of dealing with post-Soviet business, which is conducted in Russian and by informal, Russian-style rules. Of all the Baltic states, only Latvia has a golden visa program targeted at Russians willing to invest in local real estate.

The U.S. government has been concerned about the Latvian goings-on since at least 2006, when the U.S. Treasury Department's Financial Crimes Enforcement Network issued a report on the use of U.S. shell companies that had received $18 billion in suspicious transfers, mostly from Russian and Latvian accounts. In recent years, especially since Latvia joined the Organization for Economic Cooperation and Development in 2016, the concern has turned into relentless pressure on the small nation: Combating money laundering and tax evasion are among the OECD's primary goals. 

So, in 2016, Latvian non-resident banking lost much of its attractiveness. Banks stopped working with shell companies opened in most tax havens. Compliance procedures became onerous for post-Soviet businesspeople, so that opening an account was no longer easier than in most other European countries. Cyprus and Malta began to look attractive by comparison. Deutsche Bank, which provided crucial dollar clearing services to Latvian banks serving non-residents, began preparations for a pullout from this business, a disaster that struck slightly less than a year ago. In 2016, the share of foreign deposits in the Latvian banking system -- one of the few available indicators of the parallel non-resident banking system's activities -- dropped from 57.3 percent to 42.6 percent. It's still at about that level. 

This gradual process, however, has been too slow for the U.S. treasury department. Last month, it accused ABLV, Latvia's third-biggest bank, of facilitating money laundering. The examples it gave involved fugitive Ukrainian oligarch Serhiy Kurchenko, the theft of $1 billion from three Moldovan banks in 2014 and even the possible funding of the North Korean missile program. Cut off from the U.S. financial system, ABLV could no longer operate and had to be wound down by the European Union. 

And yet the U.S. is not satisfied. Latvian Finance Minister Dana Reizniece-Ozola said on Thursday that a senior U.S. official had just warned her about Latvian banks' continuing sanctions-busting activity.

The pressure on Rimsevics to leave may be ostensibly about bribery accusations against him. Yet the bigger issue is that the central bank governor, who was involved in the creation of the brilliant, profitable but dodgy non-resident banking system, is now a symbol of business as usual. The U.S. is no longer prepared to tolerate it, and neither, by extension, are European institutions, which were left embarrassed by the revelations in a member state. They want Latvia to turn a page and lose its 1990s specialization as a post-Soviet money pipeline, and that means a huge cleanup that only a new central bank team can credibly execute.

A window is closing for post-Soviet, mainly Russian, capital flight. It's not the last one, though: The banking systems of other small European nations, as well as the U.K., thanks to its strong offshore industry, are still helpful. Russia's net capital outflow increased in 2017 to $31.3 billion from $19.8 billion the previous year. Much of that is above board, of course, but very likely there is still plenty of murky business to be found. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website

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