Under heavy US scrutiny over alleged shortcomings in its anti-money laundering regime, Latvia is attempting to improve transparency within the country’s offshore banking sector — yet for some the troubles facing the Baltic state also call for a more robust Europe-wide, corruption fighting regulator.

A recent financial scandal in Latvia has raised questions about the efficacy of the eurozone banking regulator, the European Central Bank, which has supervisory oversight of member state institutions — essentially monitoring their financial stability — but does not have powers to investigate money laundering, a task that is left to individual authorities. 

Some of Latvia’s dozen or so non-resident banks, which cater for foreign clients, have long been suspected of being used by corrupt officials and businessmen from Russia and other former Soviet states as a conduit to funnel dirty money via shell companies to the European Union and beyond. More recently, there have also been concerns that Russian funds allegedly used to finance political interference in the affairs of other countries may have passed through the Latvian banking system.  

Latvia, which joined the eurozone in 2014, has had a mixed record on probing illicit flows into its non-resident banks, in part because of the opacity of some of these institutions, which have sought to promote Swiss-style banking secrecy, and because of the rapid growth of the sector that has left domestic regulators lagging behind. Just a year after joining the eurozone, the OECD criticised Latvia’s capacity to tackle financial crime. 

The US is an important military ally for Latvia in the Baltic region, but the operations of some Latvian banks have been ringing alarm bells in Washington for some time, as they potentially provide Russians and others targeted by US sanctions, including North Korea, with a way of moving their assets around the international financial system. 

Following a probe by America’s Federal Bureau of Investigation, Latvia’s banking watchdog last July fined two local banks more than $3mn for violating sanctions against North Korea. Three other banks had earlier been fined lesser sums for similar offences. Latvia’s crackdown did little to salve US concerns, though. American diplomats were reportedly unimpressed with the size of the penalties and the alleged links to Pyongyang, at a time when US relations with the Hermit Kingdom were deteriorating.

Matters came to a head in February when the US Treasury accused Latvia’s third-largest bank, ABLV, of “institutionalised money laundering” and North Korea sanctions breaches, which led to its collapse. ABLV denied any wrongdoing. The banking sector was subject to further scrutiny just days later when in a separate development the longtime governor of the Latvian Central Bank, Ilmars Rimsevics, was accused of demanding bribes. He denied the allegations and suggested to the Financial Times that they had been orchestrated by banks keen to oust him after he tried to make the banking sector more transparent. 

In the aftermath of the ABLV affair, the Latvian authorities came under pressure to do more to clean up the country’s financial system. Progress has been made, but the process could be hindered by parliamentary representatives of the country’s 500,000 ethnic Russians, a quarter of the population, who are not persuaded of the need for further reforms. Some are concerned these would harm what they see as Latvia’s role as an economic link between Russia and the West.

Yet last month legislation prohibiting Latvian-registered banks from doing business with shell companies, unless they can prove they are legitimate businesses, came into force. The Riga authorities also aim substantially to reduce the proportion of foreign deposits in the banking system — currently over a third of the total — while non-resident banks have been told that they must review their business model. “Either they have to change their business methods or fold,” warned Latvia’s Finance Minister Dana Reizniece-Ozola. 

The new head of Latvia’s anti-money laundering agency, Ilze Znotina, has said she wants local banks to improve the quality of information on suspect transactions they send to the authority. Yet the agency also needs to up its game. A Reuters report said that 85 money laundering investigations were launched last year despite Latvian banks filing nearly 18,000 suspicious transactions.

Whether Latvia can do enough to reassure its American ally is difficult to judge. But the focus on Latvia has also raised questions about the ECB’s level of oversight, particularly because there have been similar financial crime concerns about other small European jurisdictions such as Cyprus and Malta. While the ECB serves as a regulator of eurozone banks, it has no investigative powers, which are entrusted to member states. 

Critics of the ECB argue that the bank or another supra-national body needs to be probing money laundering suspicions across the bloc, given that some member states may lack the political will to prioritise investigations or be short of the necessary resources. Resistance to external intervention, however, could come from domestic regulators who might regard it as an erosion of national sovereignty.  

Nevertheless, the case for a more robust response to the problem is strong. Rob Wainwright, the outgoing head of Europol, told the online news magazine Politico in April that professional money launderers are running billions of criminal profits through the banking system with a 99% success rate, despite banks spending $20bn on compliance. In the interview, he said Europol seizes just 1% of criminal assets in Europe annually and that Europe was losing the fight against dirty money because it has used national solutions to tackle an international problem.   

The EU is alert to the need for action. Although to date there appears to have been little progress on the issue of a Europe-wide, corruption fighting regulator, the adoption of a more coordinated approach to tackling money laundering across the bloc is in the offing. In May member states and the European parliament agreed a number of measures to control illicit cash flows, including better information sharing between European financial intelligence units, independent agencies that probe suspicious transactions. 

Wider cooperation is certainly needed to combat money laundering, but with the effectiveness of some regulators under the spotlight the big question is whether more intelligence will deliver tougher enforcement. 

Yigal Chazan is an associate at Alaco. Alaco Dispatches is the business intelligence consultancy’s take on events and developments shaping the CIS region.