Latvian authorities on watch for CIS money flows

By bne IntelliNews April 4, 2013

Mike Collier in Riga -

Listen to the words of Latvia's policymakers and the Cyprus financial crisis gives the Baltic state nothing to worry about. But look into their eyes while they are saying it, and you sense a certain desperation mixed with fear.

The reason is simple: with Russian cash certain to leave Cyprus at the earliest opportunity - thanks to the anti-Russian rhetoric deployed by the EU as much as the financial hit that Russian depositors are being forced to take - everyone is wondering where the money will head to.

The destination could be Switzerland, the US or Cyprus-like offshores in the Caymans or Virgin Islands. EU destinations London, Luxembourg and Latvia look just as likely - the latter thanks to its large Russian-speaking population, wide range of boutique banks specialising in non-resident deposits and the simple fact that, as the hundreds of Russian-registered cars cruising the Vidzeme highway from Pskov each day prove, these days it feels safer having your money close at hand.

Until recently, attracting Russian cash was all wine and roses; now it is rapidly becoming the government's worst nightmare.

Speaking to bne on March 28, the country's financial regulator, Kristaps Zakulis, said Latvia had nothing to worry about and even blamed the media for not properly understanding the situation. "There is too much speculation and too little statistics to prove such speculation," Zakulis said, insisting that the level of non-resident deposits (NRDs) in the Latvian banking system had only increased in February due to exchange rate fluctuations.

"In Latvia we are talking about tens of millions [of euros]. In Cyprus we are talking about tens of billions - they are not comparable things," Zakulis said.

Latvian banks have noticed an increased interest from overseas depositors in the wake of the Cyprus crisis, Zakulis admitted, but said it was "the same as the increased interest from journalists and the media," and had not yet resulted in substantial amounts of cash flooding into Latvia.

"We are looking at the statistics and we do not see any movements right now," Zakulis said. "If money is attracted, it should be clean money and it should meet the requirements regarding liquidity and so on."

Resident deposits in Latvian banks decreased by 0.1%, or LVL4.7m, in February from the previous month, while NRDs rose by 0.4% or LVL26.9m. During the same period, loans worth LVL13.4m were issued to residents, while LVL86.3m in loans went to non-residents.

About half the €17bn deposited at Latvian banks are in NRDs. As Zakulis says, that is chicken-feed in global terms. But the Latvian NRD sector grew by 20% last year, and the International Monetary Fund (IMF) estimates that 80-90% of NRDs come from former Soviet states (even if channelled through offshores like Cyprus). And Zakulis has written to banks warning them to be careful about "the quality of their financial flows", though the precise contents of the letter have not been made public.

Latvian Finance Minister Andris Vilks was also in lockdown mode on March 28, reassuring his Lithuanian and Estonian counterparts in Vilnius that only around 10-15% of Latvian NRDs come from Cyprus. Prime Minister Valdis Dombrovskis and central bank governor Ilmars Rimsevics were media no-shows the same day and bne only collared Zakulis for a chat in the cloakroom following a meeting between the three of them plus representatives of the banking sector.

For the question is not what the level of NRDs is now, but what it will be when the EU decides to return to the principle of free flow of capital and let the money run.

Rietumu bank, one of the most successful banks catering to the NRD sector, said on March 20 that it was extending its opening hours at its overseas branches to cope with "a large number of enquiries related to the situation regarding the financial system in Cyprus."

One of Rietumu's analysts, Igor Zuyev, also produced one of the most entertaining commentaries on Cyprus, referencing the classic Russian comedy film "Island of Bad Luck". "It is obvious to everyone that as soon as foreign depositors get access to their accounts, the majority will try to withdraw their money from the island to play it safe," says Zuyev. "At present no assets can be considered as risk free, especially in countries with weak state and banking institutions. Under the oppression of the crisis, governments can resort to the maddest and the most unfair measures which often contradict both their pre-election promises and common sense."

Yet the constant refrain of the Latvian authorities is that their banks are strongly regulated (notwithstanding the fact that half a dozen of them have been named in connection with the Magnitsky money-laundering affair and other scandals), so wouldn't Latvia be a great place to put Russian cash?

Until recently, yes - but with Latvia expecting a team from the European Commission in Riga any day to draw up a verdict on its application to join the Eurozone, officials are somewhat belatedly terrified that all this talk of dodgy Russian cash might queer their pitch.

Yet perhaps the Latvian authorities should worry more about Ukrainian money than Russian.

In a March 28 note, Capital Economics said: "Most attention has focussed on the impact that the Cypriot bail-out could have on Russian depositors, but the deal may pose much bigger risks for Ukraine, which is already on the brink of a balance of payments crisis."

The economic consultancy goes on: "Tiny Cyprus is the main source of FDI into Ukraine, accounting for around 30% of the total. The introduction of capital controls in Cyprus risks disrupting these flows, which may ultimately affect business activity and hit vital capital inflows into Ukraine... wider vulnerabilities mean that the Cypriot crisis may still be enough to tip Ukraine into a financial crisis of its own."

Given the strong and well-documented connections between the elite in Ukraine and Latvia's Trasta Komercbanka (which even Zakulis admitted to bne was one of the banks "more often involved in big scandals") and PrivatBank, a Ukrainian crisis might cause unpredictable knock-on effects in Latvia - the worst of which would be to prompt all those crooked Ukrainian oligarchs to open Latvian bank accounts and blow euro accession to kingdom come.

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