Latvia's hopes of joining the Organisation for Economic Co-operation and Development next year got a cold shower on October 21, when the international institution published a report into bribery that raised serious concerns over the Baltic state's banking system.
The Eurozone member is desperate to join the OECD. That's not least because northern neighbour Estonia is already a fully paid up member of the “rich countries' club", while Lithuania is also in contention for a place at the table. However, the country's banking sector is commonly criticised for dubious connections and potential instability.
The "Phase 2 Report on Implementing the OECD Anti-Bribery Convention in Latvia" suggests accession is far from a formality. That is partly as a result of the many Latvian banks stuffed with deposits from the CIS and the ineffectiveness of its main anti-corruption agency. Fourteen of Latvia's 20 registered commercial banks cater to foreigners, with the vast majority (about 80% according to the OECD) of those clients coming from Russia and other countries from the former Soviet Union.
More than half of Latvia's €30bn bank deposits are classed as “non-resident deposits” (NRDs) and it is this fact, along with weak financial regulation and paltry penalties for those who break the rules, that poses a threat, the OECD says. That puts the OECD in line with the likes of the IMF and EBRD, which have also noted that such deposits could leave quickly in the event of any problems. Latvia saw a huge rise in deposits in 2013 as the banking crisis in Cyprus - formerly the favoured off-shore destination for CIS clients - hit.
“Non-resident banking poses a substantial risk that money obtained from corruption committed outside of Latvia is laundered inside the country," the OECD reports. "Much of the deposits originate from countries with reportedly high levels of corruption. Funds deposited in non-resident accounts could thus be instruments or proceeds of corruption in these countries. Furthermore, the cross-border nature of transactions and the distance at which these transactions are conducted pose challenges to supervision."
Latvia's boutique banks have featured in a series of money-laundering scandals, including the notorious case in Russia involving murdered whistle-blower Sergei Magnitsky, and more recently a report by the Kroll financial investigative agency that alleged that more than €1bn from Moldova was laundered in just three days via Latvian banks, an allegation the OECD makes a point of noting.
"Existing measures have failed to detect alleged large-scale money laundering that was subsequently reported in the media. Latvia should accordingly require banks that take non-resident deposits to adopt stronger anti-money laundering measures. It should also inspect banks more frequently and sanction banks that breach relevant laws. The money laundering offence should be enforced more consistently," the OECD said.
“The media has also reported cases of foreign officials allegedly laundering in Latvia the proceeds of corruption, fraud and embezzlement committed in Afghanistan, Moldova, Kazakhstan and Russia. Very large amounts of money – in one instance USD 1 billion – were allegedly laundered in these cases,” the OECD said.
The OECD also uncovered several startling rules applied by Latvian regulators that may explain their ineffectiveness: banks are given a weeks' notice before investigators arrive, people considered “politically connected” are no longer regarded as such one year after they were last in power, and investigators are only interested in money-laundering cases involving 20 or more people. Even if caught, banks face a maximum fine of just €142,000 – peanuts compared to the billions of dollars sloshing through its banking system.
Less than 1% of suspicious transactions actually find their way onto the desks of the country's dedicated anti-graft agency KNAB, the report revealed, while understaffed investigators at another agency, the Financial Intelligence Unit, each have to deal with an average of 850 cases per year.
The current regime to counter money laundering that is overseen by Latvia's financial regulator the Financial and Capital Markets Commission (FKTK) “does not adequately address the money laundering risks posed by non-resident deposits”, the OECD said, before recommending a long shopping list of measures Latvia should implement to improve its legal and enforcement regime, and examine why it is so often the media that uncovers money laundering rather than the agencies charged with doing so.
It all adds up to a picture of a country that talks the talk but doesn't walk the walk when it comes to clamping down on bribery and corruption – one of the most important conditions of OECD membership.
"The working group commends Latvia for the significant legislative steps it has taken to fight foreign bribery both before and after its accession to the convention in May 2014. However, other implementation efforts remain at a reasonably early stage. There are particular concerns about Latvia’s criminal enforcement capacity, the laundering of proceeds of corruption from overseas, and several remaining legislative deficiencies," the summary of the weighty OECD report said.
The report also raised "serious concerns" about the effectiveness of KNAB, Latvia's dedicated anti-corruption law enforcement agency, which seems to exist in a perpetual state of internal dissent even when it is not experiencing "political interference" from outside.
"Foreign bribery allegations have not been proactively investigated. KNAB therefore needs to ensure that its personnel issues do not interfere with KNAB’s ability to investigate foreign bribery. Latvia should also proactively investigate allegations of foreign bribery, as well as related money laundering and false accounting. Enforcement efforts could be improved through increased training and closer co-operation between relevant agencies," the OECD said.
The FKTK, Latvia's financial regulator, told bne IntelliNews it was reading the report carefully. “FKTK works with OECD experts in providing relevant information on the regulatory framework and oversight trends in the industry. On some things we have managed to agree that the implemented processes are at a high level, on others, as we can see, we have not. We will take into account the proposed recommendations and will continue negotiations,” FKTK said, stressing that it planned strengthening due diligence procedures so that banks will have to be sure who they are dealing with.