Bullets, Bombs or Euros

March 2, 2015

Look at Ukraine and a few things become clear. The first is that Russia is willing to pledge bullets and troops to meet its goals. The other is that the West, and especially the EU, are more willing to fight with dollars and Euros rather than bullets.

Since the early occupation of Crimea, sanctions and financial intelligence have led the response of the west to Russia. And they have formed a large portion of the West’s responses to various crises throughout the world since the fall of the Soviet Union. Part of this is because of the immense leverage that western states retain in terms of economic power. Financing and the legal systems to protect business dealings have made western states crucial nodes in international economics.

Along with this leverage has come the normative power of promoting democracy, human rights and liberal values throughout the globe. This normative power is a key aspect of the EU’s identity and cohesion—especially since it retains no coherent military identity and disjointed foreign policy making.

Yet that normative power and rhetoric is undermined by the welcome mat that is rolled out for capital from authoritarian regimes, dictators and those engaged in any number of illiberal activities. Money laundering from the former Soviet sphere, in particular, has been a prominent feature of EU financial systems since the breakup of the Soviet Union. This capital has caused economic panic, Cyprus, infiltrates politics, like in Britain which our editor-in-chief Michael Weiss has documented, and enables authoritarian regimes to selectively engage globally by gaining access to international capital, providing patronage to elite supporters and supporting economic growth at home. While the west criticizes human rights abuses, it often has no problem cashing checks from those very same regimes.

That is not to say the EU does not have the necessary anti-money laundering standards. They do. But the problem is enforcing them, caused by not looking too hard at the true provenance of capital for fear of losing business to other financial centers. These factors are compounded by the nature of the EU and the Eurozone especially. Once capital enters the Eurozone, much like people who first gain entry to the EU, it is allowed almost unhindered access to any destination without the stigma and risk profile of transactions which come directly from Moscow.

This means that launderers don’t sent their money directly to Britain; they first pre-wash it through several less-scrutinizing locales to lower the risk and perceived illegitimacy of it. And smaller states of the EU (Austria, Cyprus, Latvia) that are heavily dependent upon foreign capital, make attractive entry points for just such launderers.

Recently, NYU Professor Mark Galeotti and I published a paper, “Latvia and Money Laundering: An Examination of Regulatory and Institutional Effectiveness in Combating Money Laundering” that examine just how integral one small state is in moving massive amounts of illicit capital into not only the Eurozone but the global financial system.

Latvia, since its independence, has a large financial sector that caters to foreign capital, particularly from the former Soviet Union. So large in fact that foreign capital accounts for half of all deposits. This makes a small state like Latvia much more exposed and vulnerable to not only economic risks such as rapid financial flows, but political as well. Since Latvia is so reliant on foreign sources of deposits, it is open to leverage from other states, namely Russia.

Why Latvia? The simplest answer is that it is not Russia. It has a stable legal system, and is a member of the EU and Eurozone. This makes capital coming from Latvia look far less suspicious than wire transfers coming from Moscow or Central Asia. Due to this, Latvia is a very attractive laundering spot to disguise the true nature and owner of illicit capital.

And as an attractive laundering spot Latvia has been the scene of massive corrupt deals involving Ukrainian oil rig purchases, arms trafficking, and even handling a large chunk of money from the infamous Magnitsky case. Despite these cases, it does not mean that Latvian authorities are actively encouraging money laundering and illicit flows. It is just that Latvia is a small country with limited resources, both financially and in terms of manpower. It simply has other issues and areas that require its attention. Latvia has all the necessary laws and institutions, but until recently it has decided not to rigorously enforce them or sanction the banks and corporate service providers (companies that register and create companies and bank accounts) that willfully engage in dubious activities — in large part over fear of scaring away foreign capital to other financial centers.

Our paper even caused something of a stir with Latvia’s banking regulator and financial intelligence unit, which released a press statement regarding our paper:

It is no secret that part of Latvian banking sector operates as the regional financial centre servicing non-resident cash flow. However, not only benefits are associated with such banking business model but also certain risks, addressed also by international experts, at the same time highlighting the progress in managing these risks1. Therefore, timely identification and appropriate management of these risks are among the key tasks for both the market operators and regulatory institutions

The authors of the publication “An Examination of Regulatory and Institutional Effectiveness in Combating Money Laundering” also emphasize one of such risks – a possibility that Latvian banks have been allegedly involved in attempts of money laundering. Though admitting that the Latvian regulatory framework meets all the international standards, the authors of the publication point out that above measures do not prevent the possibility of illegal transactions with customers from Eurasia through local banks.”

Read the full release here.

Just having rules and regulations is not sufficient. The will to actively enforce them is required, and Latvia, along with a number of other EU and OECD states (the U.S. also has its own significant failures in combating money laundering and corrupt proceeds), have demonstrated a continued unwillingness to do so.

For most the issue of money laundering would seem like a academic exercise into a rather mundane issue. But as recent events have shown, the movement of money is an integral role of not only diplomacy but war as well.