Analytics, Banks, EU – Baltic States, Financial Services, Latvia, Modern EU

Banking sector and the whole financial market in Latvia for the second half of 2018 has been attracting public attention both in the country and abroad. The reasons for that are of a double nature: first, the ABLV’s liquidation procedures and second, the detention of the National Central Bank's Governor, Mr. I. Rimshevichs (further on, IR).

Both events are quite extraordinary "cases": ABLV has been the 3^rd largest by assets bank in the country; more on that below. The Governor of Latvia’s Central Bank has been detained by the country’s anti-corruption agency. Latvia’s finance minister has urged IR to relinquish his post while an investigation took place; the latter refused.

It is in fact impossible to sack “the first banker’ in Latvia through an “ordinary procedure”: first, for the Central Bank Governor’s position he was nominated by the Latvian Parliament; second, he is still a member of ECB's governing council (Latvia is a euro-zone member), which gives him certain immunity and he cannot be dismissed from his position without a corresponding accept from the ECB. However, the criminal case against IR has been open at the end of June 2018.   

There are fears that the both cases could harm Latvia’s economy, which start recovering in 2017 after losing more than a fifth of its output during the global financial crisis.

Source: http://www.euronews.com/2018/02/18/latvia-central-bank-governor-detained-by-anti-graft-agency

Latvian banking sector: non-residence's dominance

After ABLV's "case", the US as well as European "regulators" have forced Latvian banking sector reduce the share of non-residents in Latvian banks. Finance minister, D. Reznice-Ozola acknowledged the government's intention to impose a tax on all "risky-clients transactions". Most probably, huge non-residents' capitals will flow to other "safe heavens"; the amounts are quite big: about 40% present non-residents' assets, i.e. about EUR 8 bln would make a solid hole in the national budget and the whole Latvian economy as well.

Source: Latvian daily "Today", 27 February 2018, p.5.

Since 1990s and up to 2014 (the year of Western sanctions against Russia), there were three “main drivers” in the Latvian economy: a) transit-transport facilities, b) EU funds, and c) financial/banking services. During last four years transit and port activities have been heavily decreasing; the EU funds most probably will be reduced by about a third in the years to come. 

That was the main reason why Latvian authorities “closed their eyes” on fraudulent banking activities with non-residences’ accounts, which provided significant revenues to the country’s budget. Although export of various manufacturing goods (generally of agro-origin) made sufficient additions to Latvian growth, it is apparently not enough to compensate for deficit imposed by non-residence's escape. Under the EU sanctions on Russia, Latvian exporters are suffering a fierce economic blow.

For decades, Latvian banking sector has been very profitable both for Latvian budget and the political system (as certain percentage of revenues has been railed into leading political parties, which is presently seen in IR’s case). However, since February the banking sector is under heavy pressure: the share of non-residents' financial investments (according to the government's intentions) is going to be reduced to about 5% instead of present 40%. Some think it is too muck a reduction and suggest about 20%, as was acknowledged by Edgars Putra, Ministry of Finances' parliamentary secretary in February 2018.

According to Bloomberg data, most clients in ABLV were from Russia – 43%, followed by Ukraine -21%; bank’s connections with the latter were really strong: some prominent people connected to Ukraine used ABLV’s accounts, e.g. country’s ex-president V. Janukovich, former Ukrainian's US adviser Pol Manafort and several others.

ABLV bankruptcy’s story in short

By the end of 2017, the ABLV’s assets reached EUR 2,7 bln; more capital was only in Swedbank - 4,4 bln; on the third place was SEB bank with EUR 2,3 bln.

The ABLV’ capitalization has been at the level of EUR 3,6 bln; higher figures were only in Swedbank (EUR 5,1 bln) and SEB (EUR 3,7 bln).

The ABLV’s profit reached about EUR 50 mln in 2017; it was the second largest profit in the country’s banking system: first was Swedbank with about EUR 70 mln followed by SEB with little over EUR 30 mln.

Reducing non-residence's dominance in the Latvian banking sector is definitely a good idea; but how and by what means to cover a big hole in the national budget?

The share of industrial production in Latvia is still below 20%, which is the level required by the European Commission; presently is at the level of 14%. Besides, there is still a deficit in Latvian foreign trade of about €300 mln; it has been over €1 billion during the last decade.

ABLV’s liquidation is going on for already a couple of months: main complications are of non-residence “concern”; some could hardly be identified. Below is an example of how quick the process went on in Estonia.           

Note: Estonian example. On 26 March 2018, the European Central Bank withdrew Versobank AS's authorization to operate as a credit institution, upon recommendation of the Estonian Financial Supervision Authority. On 28 March 2018, Eero Kaup, Viljar Alnek and Ksenia Kravtšenko from KPMG Baltics OÜ and the law firm KPMG Law OÜ were appointed as liquidators of the bank. 

Already on 5 April 2018, the Estonian Guarantee Fund and Versobank’s liquidators started to compensate to the bank’s clients the funds in deposits and bank accounts of up to EUR 100,000. In two months, the Guarantee Fund has paid out compensation to 2,505 customers in the amount of EUR 88.9 mln.

All depositors who have submitted timely applications will be compensated for sums of up to EUR 200,000 plus an additional 30% of the balance exceeding this sum in the coming weeks. For example, if the account balance was EUR 300,000, another EUR 30,000 will be paid out.  

More on the bank's website http://www.versobank.com.

Nordic dominance in the Baltics

The Baltic States’ banking system is quite big: there are 16 banks in Estonia, which include 6 domestic banks and 10 foreign-controlled banks (with branches and subsidiaries). There are 18 commercial banks in Latvia and there are six banks and eight foreign bank branches (i.e. 14 in total) in Lithuania.

The three Baltic State are having their independent central banks; all 3 states are members of the Euro zone. The core tasks of the national central banks are to help to define the monetary policy of the European Community and to implement the monetary policy of the European Central Bank. Besides, they are responsible for holding and managing national official foreign exchange reserves as well as supervising overall financial stability and maintaining reliable and well-functioning payment systems. The national central banks have to see that Maastricht criteria for financial system are implemented.

Estonian banking sector is dominated by two major Nordic commercial banks, Swedbank and SEB, owned by Swedish banking groups; these two banks control approximately 62% of the financial services market. The third largest bank is an affiliate of the Finnish Nordea group, and the fourth largest bank is an affiliate of the Danish Danske Bank.

Total assets of the domestic banks comprise only about 13% of the Estonian consolidated banking assets. There are no state-owned commercial banks or other credit institutions.

See more in: https://www.export.gov/article?id=Estonia-Banking-Systems.

The “domination” has lead to dramatic events in Estonia. The Danish Danske Bank’s subsidiary (filial) in this country is being accused of laundering billions of euros of “shadow” transactions since at least 2013. However, the filial was closed only at the end of 2015 (!) with investigations started at the end of 2017. Presently criminal procedures are opened against 26 bank’s servicemen in Estonian police (according to the Danish media, see: Politiken 28.07.2018. p.8). Danske Bank’s officials acknowledged that “the case” will be closed somewhere in September…   

There are 18 commercial banks in Latvia; among the biggest five banks (by total assets in bln euros) are: Swedbank - 5,5; Luminor Bank*) - 4,8; SEB banka - 3,6; Citadele banka - 2,5 and Rietumu Banka - 2,3. The first three are Nordic banks and/or their subsidiaries.

*)Note: In October 2017, DNB Bank ASA (Norway) and Nordea Bank AB (Sweden) have combined their Baltic business into a jointly owned bank, Luminor Bank.

Total assets of Latvian commercial banks were € 25.7 billion in March 2018, a little lower than in 2017; the commercial banks’ sector is making about €100 billion profit on a yearly basis.

Total assets managed at Latvian banking sector were € 1.1 billion as of March 2018 (table 73 in www.lka.org.lv).  References and sources for statistics from: https://www.lka.org.lv/wp-content/uploads/2018/06/Detailed-results-of-Latvian-commercial-banks-1st-quarter-2018.pdf . General source: www.lka.org.lv    

According to the Association of Lithuanian Banks (it has a wonderful motto: “Creating confidence”), there are six banks and eight foreign bank branches (i.e. 14 banks in total); as in other two Baltic States, Lithuanian banking sector is dominated by the subsidiaries of the big Scandinavian banks from Sweden and Norway: SEB, Swedbank and DNB. Besides, there are 74 credit unions in the country, but state has no stakes in the banking sector.     

Source: https://www.ebf.eu/lithuania/

In the conclusion one has to acknowledge that the dominance of Nordic banks in the three Baltic States alongside positive consequences has had also some negative ones as well. The Baltic States’ “financial ambitions” have been very high after regaining independence in 1992: e.g. Latvian financial sector’s ambitions were to create a “Baltic financial center” on a global level. For several decades such “wishes” produced some profitable results: for several years these countries were regarded as the “Baltic tigers” in GDP growth. 

However, digital information in the financial sector makes “shadow” transactions quite difficult in future: the ever-growing accumulation and use of digital data both raises challenges for private/public cross-border transactions and “openness” in the cross-border use of all the financial data.

So even if there might be some political interests to “milk the shadow transactions”, their days are counted.

It is still important is to look at the EU legal financial framework and its loopholes, and see the possibilities to adapt this framework to the EU states' digital economy and national banking system.