Bank Clampdown Dims Allure of Scandal-Hit Baltic Haven

(Bloomberg) -- Many Latvians got a shock this summer when they were informed their bank accounts risked being blocked if they didn’t hand over details of their citizenship, financial plans and any ties to high-level politics.

Demands to fill out online questionnaires were dispatched by lenders at the behest of financial regulators, who’ve been battling the Baltic nation’s reputation as a shelter for illicit cash. The crackdown is changing the face of Latvian banking, which flourished as the Soviet Union crumbled and has long been a magnet for wealthy clients.

Having spent years sucking up money from the ex-communist region, inflows have begun to reverse as regulators tightened rules, doled out record fines and, in one case, shut down a lender over money-laundering allegations. Non-resident deposits, which eclipsed domestic savings for four years, are on the wane, now representing less than half the total.

“This is the next chapter in Latvian banking,” said William Schaub, a lecturer in risk management at Riga Business School who’s previously held senior roles at GE Money Bank in the Baltic country’s capital and Merrill Lynch in the U.S. “It’s important Latvia adapts and continues to export financial services.”

The shift comes after revelations from the Panama Papers sparked calls for harsher controls over illicit cash flows, and amid an anti-money laundering drive by the European Union.

It also follows a string of scandals. Latvian banks have been accused of handling some of the $1 billion stolen in 2015 from Moldova’s financial system, helping shift as much as $20 billion in illicit cash from Russia between 2010 and 2014 and facilitating bribes by a Scandinavian telecommunications company.

The International Monetary Fund has also warned against allowing an over-reliance on non-resident cash, which can be volatile, particularly during periods of market stress. Latvia’s financial-services market is dominated by Nordic lenders such as Swedbank AB and SEB AB, which don’t focus on non-resident business. Nordea Bank AB and DNB ASA agreed last month to combine their operations in Latvia, Lithuania and Estonia.

After criticism from the U.S. and the Organization for Economic Cooperation and Development on client vetting, regulators have acted. The Financial and Capital Market Commission has hired more staff, tightened reporting standards, handed out unprecedented fines and made banks focused on non-resident business undergo a compliance audit by two U.S.-based firms at their own expense.

Crime, Punishment

There have been casualties. Trasta Kommercbanka AS, implicated in the $20 billion scheme, was shut down in March, though it denies wrongdoing. Privatbank AS’s Latvian unit was hit in December with a record 2 million-euro ($2.2 million) fine for handling money from the Moldovan fraud.

The two biggest non-resident banks have both reported deposit outflows. ABLV Bank AS recorded a 14.3 percent plunge in deposits the first half of 2016, citing changes in its model for servicing foreign clients. Rietumu Banka AS notched a 10 percent decline in that period. Both declined to comment beyond their accounting reports.

Compounding matters is reduced access to U.S. dollar correspondent accounts, used for global transfers, as multinational banks grapple with demands for higher capital, falling profitability and tighter regulations. Deutsche Bank AG is preparing to close dollar accounts with some Latvian lenders, according to people familiar with the decision.

Sanctions, Currency

While the regulator acknowledges a shift is taking place, it’s not all down to the stricter regulatory environment, according to spokeswoman Ieva Upleja.

“Stricter anti-money laundering demands require banks to review their client base,” Upleja said by e-mail. But she also cited fallout from U.S. financial sanctions against Russia, and the effect of a weaker dollar, the currency in which about two-thirds of foreign deposits are held. Aggregate account data are reported in euros.

And the measures have been welcomed by the U.S. Vice President Joe Biden, visiting Riga as part of an August trip to Europe, highlighted “the progress Latvia has made in tightening regulation of its banking sector and cracking down on money laundering.”

Even so, the new environment is prompting changes at lenders unaccustomed to the rigorous checks and balances now sought.

Banks have declined to work with some “customers whose service may be connected with disproportionate risks,” Baiba Melnace, a spokeswoman for the Latvian Association of Commercial Banks, said by e-mail. They’ll “continue to carefully evaluate their customer base, as well as changes in the business model.”

Peters Putnins, Latvia’s chief financial regulator, put it more strongly.

“It will never again be how it once was,” he told the Neatkariga Rita Avize newspaper. “A few banks’ actions can really create undeserved difficulties for others, and can harm the state’s reputation and prestige.”

To contact the reporter on this story: Aaron Eglitis in Riga at aeglitis@bloomberg.net. To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net, Andrew Langley, Patrick Henry