Latvia warned again on homeless Russian cash

By bne IntelliNews May 6, 2013

Ben Aris in Moscow -

When the EU effectively closed down Cyprus' offshore banking regime last month it made some $20bn of Russian money homeless. One of the more likely new havens for that cash is the Latvian banking sector, and despite denials from Riga, Moody's warned on May 2 that Russian cash is already starting to arrive.

Russian deposits have gone from a boon to a liability. Thanks to the haircut imposed on depositors in Cyprus, storing large amounts of Russian cash now almost guarantees that you won't get an EU-backed bailout if your financial sector gets into trouble.

The upshot is no one wants to open their doors to the vagabond Russian cash. However, Latvia is heavily exposed as so many Russian businesses already have accounts there, making it hard to stop them depositing more money.

That is the main reason Latvia is such an obvious destination. It's also in the EU but Slavic. As a legacy of Soviet days there's a large Russian population, while several boutique banks cater specifically to Russian businesses looking for an banking entrepot into the EU.

Moody's Investors Service said that in the last month the volume of Russian cash leaking out through the capital controls Cyprus imposed at the end of March is already increasing and putting pressure on Latvian banks. According to data from the Central Bank of Cyprus, €6.4bn left at the end of 2012, but no one is clear how much has left since March.

The Latvian Finance and Capital Market Commission (FCMC) said in April that the volume of deposits made by non-residents increased by approximately €400m in the first quarter of the year and is rising. Non-resident deposits, which make up almost half the Baltic nation's total, rose 32%in the last two years, while domestic savings fell 2%, Moody's points out in its report.

"We expect further deposit inflows into the Latvian system, which is stable by comparison [with Cyprus], although we recognize such flows are currently limited by the capital controls," Moody's analysts Richard B. Foster and Simon Harris write.

However, currently at least, the Latvian banking sector is in a lot stronger position than that of Cyprus, despite its previous proclivity to offer banking services to Russia. It's financial sector is reassuringly small; the total nominal value of the economy was $22.2bn in 2012, according to the World Bank, with the banking sector accounting for a relatively modest 90% of GDP, way less than Cyprus' 800%.

The issue is that if an outsized banking sector like Cyprus' gets into trouble then the government has no hope of mounting a rescue. It simply has nowhere near enough to bail out a beast that is multiple-times the size of the whole economy. Latvia's banking sector, on the other hand, is small enough for the government to deal with any problems on its own - in theory anyway.

By way of comparison, Slovenia already has a huge $3bn-$4bn hole in its banking sector balance sheet due to bad loans. Ljubljana points out that its banking sector is only about 50% of GDP, and insists it can deal with the problem on its own, and that there's no need to panic.

However, Latvia's banks are not big borrowers on international capital markets, and depend on deposits to fund their operations. Therefore, the question of where this money comes from is sensitive: Moody's notes that foreign deposits are a lot less stable than domestic deposits, and 49% of the money on account in Latvia is foreign - almost all of which is thought to be Russian.

"Deposits of non-residents create additional risks, because they complicate the banking system, which threatens the stability of the financial system," the agency warned.

And that's the crux of the problem. Taking in an extra €400m of Russian cash is not an issue, but if the country takes in all of the €20bn currently looking for a home then that would double the size of the banking sector to about 200% of GDP, and boost the share of foreign money to around three-quarters of the total on account. Put together, this makes Latvia susceptible to a very nasty banking crisis - and because the money is Russian, it can be almost certain that the EU won't step in to help if Riga does get into trouble. Not surprisingly the Latvian authorities have been quick to deny that the county is a haven for Russian cash.

"It is not true that Russian money from Cyprus is flooding into Latvia: extensive investigation by our office has confirmed that any changes in total non-resident accounts in 2013 are consistent with historical averages. Latvia's $10bn in total non-resident deposits is not remotely close in size to the $75bn that flowed through Cyprus," Kristaps Zakulis, the Latvian financial regulator, said on April 24.

However, details on exactly what is going on remain sketchy. Moody's said the inbound money is not equally divided among Latvian banks. While the agency thinks that part of the increase in deposits is simply due to the economic recovery that Latvia has recently enjoyed, at the same time deposits from the Commonwealth of Independent countries (CIS) have also played a "significant role" in Latvia's banking system growth. The question now is how much more money will end up in Latvia.

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