Swiss-Style Latvian Banking Hub Thrives on Ex-Soviet Cash

Latvian banks are holding more foreign cash than ever before as Cyprus’s economic woes prompt wealthy depositors from the former Soviet Union to seek an alternative offshore home for their money.

As non-European inflows into Cyprus stagnate, about $1.2 billion flooded into Latvia in the first half of the year. Non- resident deposits are now $10 billion, about half the total, regulators say, exceeding 43 percent in Switzerland, according to that nation’s central bank.

Accounts in Latvia, a banking hub since Soviet times, are swelling as Cyprus seeks bailouts of $19 billion and capital flees Russia amid protests at President Vladimir Putin. While the deposits can buoy credit, they risk banking stability, the International Monetary Fund says. Regulation and client vetting aren’t up to scratch, according to the United Nations and Global Witness, which allege illicit ties to Central Asia and Africa.

“Latvia will remain quite an attractive place,” Finance Minister Andris Vilks said in an Aug. 9 interview in Riga, the capital. “There are still quite strong signals that money’s leaving Russia, Cyprus and other destinations en route to somewhere else in the European Union.”

$32 Trillion

About $350 billion of capital has left Russia since 2007, according to the central bank. The global market for non- resident deposits is as much as $32 trillion, according to the London-based Tax Justice Network, established by the U.K. Parliament in 2003 to study tax evasion, tax avoidance, tax competition and tax havens.

After surging 41 percent from 2007 to 2011, non-euro-area deposits at Cypriot lenders fell 85 million euros ($104 million) to 21.8 billion euros in the 12 months to June, central bank data show.

The cost of insuring Cypriot government debt for five years using credit-default swaps has jumped more than 200 basis points in the last five months to 1,381 yesterday, exceeded only by Greece, data compiled by Bloomberg show.

Latvia exited an IMF-led bailout program in December and was the EU’s fastest-growing economy in the second quarter, when gross domestic product advanced 5.1 percent from a year earlier. Its swaps have plunged 137 basis points in 2012 to 228 basis points. A basis point is 0.01 percentage point.

Soviet Legacy

Latvia’s Parex Banka claims to have been the first Soviet lender to receive a private foreign-exchange license in 1990, helping ignite the country’s status as a regional banking hub.

The nation of 2.1 million people has the highest share of Russian speakers among the three Baltic states and state-owned carrier AirBaltic AS offers direct flights to destinations across the former Soviet Union including the Uzbek capital Tashkent and Baku in Azerbaijan, as well as Moscow.

“Latvia’s benefiting from its proximity to ex-Soviet markets like Russia and Ukraine and the fact that Russian is widely spoken,” Gene Zolotarev, founder and chairman of Geneva- based wealth-management company Maximus Capital SA, said July 17 by phone.

Non-resident deposits are a “short-term liability” and the renewed inflows may jeopardize the collective stability of Latvia’s 25 banks, the International Monetary Fund said July 16.

‘Mixed Blessing’

“Non-resident deposits are a mixed blessing,” the Washington-based lender wrote in a report. “The increasing size of the non-resident banking system could pose risks to the financial system and be a potential drain on international reserves, unless short-term liabilities are matched by equally liquid foreign assets.”

Non-resident deposits plunged almost 30 percent, or 1.8 billion euros, in the year from August 2008 after Parex, the biggest domestically owned lender, needed a 1.1 billion lati ($1.9 billion) state rescue. That forced Latvia to take a 7.5 billion-euro international bailout as central bank reserves dwindled by about a third.

Non-resident deposits also fell in 2005, when the U.S. Treasury threatened to bar two Latvian banks from the American financial system in an effort get tighter anti-money laundering laws passed. It later dropped sanctions against Multibanka, while Latvian regulators annulled VEF Banka’s banking license in 2010.

Some of the Baltic nation’s lenders have been accused of impropriety more recently.

Africa, Kazakhstan

Latvian companies helped Cote d’Ivoire officials violate international sanctions, according to an April 12 report by the United Nations Security Council. A commander from the African country obtained a credit card at Parex under a false name, the UN alleges.

Christopher Gwilliam, who took over as head of Parex in 2010, later renamed Reverta, said he couldn’t comment on the allegations because he didn’t have enough information.

Closer to home, business with central Asia has raised questions.

In Kazakhstan, offshore companies related to the former chairman of BTA Bank (BTAS), Mukhtar Ablyazov, were accused of defrauding what was once the country’s biggest lender out of more than $1 billion, steering the cash through Latvia’s Trasta Kommercbanka AS, according to London court documents.

Agita Musina, a spokeswoman for Trasta, said Aug. 22. by e- mail that client information is confidential and the lender adheres to Latvian law and international banking standards.

‘Swiss Baltic’

In Kyrgyzstan, about $30 million was allegedly channeled through ABLV Bank AS, Latvia’s biggest bank by deposits, in transactions that may constitute money laundering, anti- corruption campaign group Global Witness said in a June 17 report.

Latvian banks are “almost like a Swiss Baltic state,” according to Tom Mayne, an analyst at London-based Global Witness. While this has benefited the economy, it opens to the door to potential illegal activity, he said in a June 28 phone interview.

“If a country such as Latvia is acting as an unwitting bag man for various corrupt regimes, I think there are serious questions it has to answer,” Mayne said.

There was nothing illegal about the Kyrgyz transfers, according to Ernests Bernis, chief executive officer of ABLV, the largest holder of non-resident deposits with about $3 billion.

Foreign deposits benefit Latvia, boosting GDP through financial-services exports as well as increased economic activity as clients buy local property and use amenities, he said in a July 31 interview at ABLV’s headquarters in Riga.

Lending Shrinks

Nordic lenders such as Swedbank AB (SWEDA), SEB AB (SEBA) and Nordea AB (NDA), which control about 40 percent of Latvia’s banking assets, have scaled back credit in the Baltic region for the last three years, IMF data show. Latvia’s outstanding loans fell 11.7 percent from a year earlier in the second quarter, according to the bank regulator.

After the Parex failure, Latvia’s regulator says it’s protecting the economy from a sudden withdrawal of non-resident deposits by forcing the banks that hold them to set aside more capital and liquidity.

“The crisis has taught us a lesson about what kind and how liquid the securities banks” hold against deposits should be, Kristaps Zakulis, who took over as head of the regulator after Latvia’s sixth-biggest deposit bank, Krajbanka AS, collapsed last November amid a fraud allegations, said in a July 31 interview in his Riga office. “There’s been a change in this view.”

Stricter Rules

The last lender to get a banking license must maintain a capital adequacy ratio of 20 percent because of its non-resident business, according to Zakulis. The last bank to receive a license was Rigensis Bank AS. The nation’s minimum requirement is 8 percent, and the average ratio was 17.2 percent at the end of June, according to the regulator.

The regulator can demand higher capital and liquidity ratios for lenders depending on the level of non-resident deposits and non-resident lending.

Still, Latvia is retaining its popularity as a banking hub.

Otkritie Capital, the brokerage part-owned by Russia’s VTB Group, is interested in acquiring a lender in the Baltic nation to gain access to the EU market, Alexey Karahan, a Moscow-based spokesman, said June 14 by phone.

It has applied to buy GE Money Bank and is awaiting regulatory approval, Eugenia Pryadko, head of Otkritie’s press office, said Aug. 22 by e-mail.

ABLV, whose clients are about 40 percent Russian, predicts Latvian non-resident deposits will continue in the years to come as other destinations lose their sheen.

“The recent events in Greece have negatively affected Cyprus,” he said. “We don’t see any barrier to business doubling or tripling in three to five years.”

To contact the reporter on this story: Aaron Eglitis in Riga at aeglitis@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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