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Morningstar | All Aboard the Money Laundering Train; New Reports Implicate More European Banks

Over the past days a consortium of investigative newspapers, online portals, and television programs revealed a web of money laundering activities flowing through the European banking system, which lay bare a different scale and urgency of the problem of anti-money laundering controls within most banks as well as regulators than previously acknowledged. Of the banks named thus far to be involved we cover Danske, Nordea, Swedbank, Raiffeisen, Erste, RBS (acquired the unit in question from ABN in 2008), ING, and Deutsche Bank. While other Nordic banks as well as other banks in our coverage have not been directly linked to this publicly yet, we cannot conclude that the list given above is exhaustive given that banks without Baltic exposure have been implicated as well. As we digest the news, we do not alter our fair value estimates or moat ratings for any of the banks involved as of now, we may, however, do so in individual cases based on the varying scale of involvement and culpability.

The news on money laundering activities in Europe up to this point had been dominated by Danske, the largest Danish lender, and its small Estonian branch which admitted to EUR 200 billion of potentially suspicious nature flowing through the entity. According to the new allegations, it seems that Danske’s Estonian branch, together with two Lithuanian lenders, have been the gateway into the European banking system for a or several large and complex money laundering apparatuses using offshore shell companies opening accounts to obfuscate the origin of funds transferred. As we understand it, most banks involved in the newest revelations were used to receive monies brought into the system via Danske or the Lithuanian banks. Further, we understand the issue to be of knowing-your-customer practices rather than actively facilitating money laundering, which we believe needs to be distinguished.

The information available is sparse, especially since banks involved either did not comment or can conveniently hide behind bank privacy laws blocking them from discussing any transactions or clients in question. What we do know at this point is that in the act of following tax fraud money from Russia, the Hermitage Fund spearheaded by Bill Browder has gained access to a vast number of transactions that also give insights into other money laundering activities in the European banking system. According to these documents, allegations are made that European banks, several of which are under our coverage, have allowed shell companies to open accounts and receive vast sums of money without the banks’ knowledge of who the beneficiaries are. Furthermore, the allegations claim that these practices had to be of criminal intent as the transactions would have raised red flags that had to be ignored purposefully. Unfortunately, we are right now stuck in this “he said--she said nothing” conundrum. Judging by the developments at Danske, we expect banks to first deny knowledge, then cite bank privacy laws before they hide behind ongoing investigation secrecy requirements. We believe the ultimate question is not whether the banks did allow accounts to be opened by shell companies, as this seems as a likely scenario to us, but rather if and when banks reported these accounts as suspicious to regulators and how regulators react to these revelations. As has been touched upon by one of the Austrian online portals, part of the consortium behind the allegations, RBI, for example, has likely been a driving force behind a criminal investigation into a small section of the laundromat scheme after it saw transactions of several accounts getting out of hand. RBI has not been reprimanded or fined for the involvement at the time, suggesting that supervisors were content with the actions by RBI at the time of eventually escalating the issue to supervisors. The interconnection between supervisory authorities and banks as well blurry the line between when a bank needs to report suspicious transactions to be off the hook and when it becomes part of the illegal activity complicates matters immensely.

The problem of lax anti-money laundering controls brought into the spotlight are more complicated than would appear at first glance. The ultimate responsibility of adequate controls forms a business risk carried by the bank and ultimately the investor. We do not think this is purely an idiosyncratic issue, however. As we alluded to already, the term money laundering can give the wrong impression to what is likely occurring within the bank. The range of possible involvement in money laundering schemes for a bank can go form negligence over ignorance to facilitation of illegal activities. We believe that most banks under our coverage likely fall somewhere between negligence and ignorance, which could result in reprimands and fines, and rightfully so. The scale of the allegations and the network uncovered does put into question how the regulatory landscape has facilitated this as well, however. The banks’ practice of turning a blind eye or asking questions after the fact have been tolerated by regulators until now. The lack of a unified supervisory authority is just one example how a grey zone of accountability is created in which fraudulent monies can slip through. Regulators and supervisors will have to rethink how to tackle this issue as we do not anticipate banks to turn clients away themselves. Higher regulatory costs related to know-your-client initiatives are a likely scenario, although improvements have been made already.

- DANSKE, SWED A, NDA SE, SEB A -
Danske has admitted that between 2007 and 2015 funds of about EUR 200 billion of potentially suspicious nature flowed through its Estonian branch. It appears now that the branch was used as the gateway for ill-gotten gains to spread through the European banking network, largely originating from former CIS countries. Danske likely failed to properly check who the beneficiaries are of the shell companies used to transfer vast sums through the Estonian branch. The share price declined about 50% last year as the news kept unfolding, and Danske saw itself in the position to give concession to its mishandling of the situation multiple times. As we highlight in our company report, we believe that the low share price is largely driven by the lack of information available, the sheer size of the potentially suspicious funds, and the looming possibility of having its U.S. dollar clearing license revoked. For our view on why the market is putting undue weight on these issues please refer to our company report.

Swedbank has long claimed not to have been caught in the web of fraudulent funds flowing through Estonia. As a television program in Sweden revealed, it was right in some way. Swedbank likely did not receive funds from shell companies or individuals with bank accounts originating in CIS countries as appears to be the case for Danske. But, such funds were transferred from Danske accounts to Swedbank’s accounts, nevertheless implicating Swedbank. The amount in question is about USD 4.3 billion. The difficulty in analysing the situation is that the bank, like all its peers, hides behind bank privacy laws or claims no knowledge when it comes to the important questions. The fact that the money flowed to Swedbank in itself is not of concern to us, rather whether the bank flagged the transactions to regulators as suspicious. In our understanding, the bank would be off the hook if all transactions were reported. The fact that the bank cannot say it reported the transactions under question as suspicious but rather does not comment based on privacy laws we believe makes the market doubt all was adequately reported. We have no indication to believe otherwise ourselves.

As revealed by a Finish broadcaster, EUR 700 million in suspicious funds are said to have been flowing through Nordea, the largest Nordic bank, from former CIS countries. The bank had previously vehemently denied any involvement in the matter. Again, we are unable to dissect which if any of these transactions have been adequately flagged to regulators. Given that flagging these transactions would have raised alarm bells with Danske as well and the need for a third-party consortium to publish its money laundering findings to generate traction in tackling these issues does make us question if these transactions were adequately reported at the time or if they were reported where they fell on deaf ears.

Skandinaviska Enskilda Banken is not yet named as one of the banks involved in the scandal as far as we are aware. We do note, however, that the bank did have exposure to the Estonian market at the same time as Danske, Nordea and Swedbank for the period in question. Additionally, we cannot exclude the fact that suspicious money may have moved from Danske or another European bank to accounts offered by SEB.

- DBK -
Deutsche Bank had been the corresponding bank for Danske and is alleged to have processed up to EUR 31 billion is suspicious funds on its behalf. The company denies having had adequate information to perform a know-your-customer analysis on the transactions, however. Having cleared the transactions in U.S. dollars, which is a common activity, has brought Deutsche and Danske into the purview of the U.S. Department of Justice, which opened an investigation into both banks.

USD 889 million are alleged to have been transferred from bank accounts at Deutsche Bank to accounts of the money laundering scheme revealed by the Organized Crime and Corruption Reporting Project.

- RBS/ABN, INGA -
Nearly EUR 1 billion in total flowed through the Dutch banking system, the lion’s share went through two Russian banks with a Dutch banking license, however. Accounts at formerly ABN, the unit was bought by RBS in the fallout of the financial crisis in 2008, received about EUR 190 million in funds through the laundry system.

ING was also involved in the laundromat scheme, although with its operation in Moscow rather than its Dutch business. The funds in question amount to about EUR 1.7 billion according to the Belgian anti-money laundering authority. In 2009, ING reported to Belgian authorities that these accounts may be used for money laundering activities, after which an investigation into the matter was shutdown due to lack of evidence that the funds originated from illegal activities. Last year, ING settled with Dutch authorities on a fine of EUR 775 million for lax anti-money laundering practices, we believe unrelated to the case above, however.

- RBI, EBS -
Both RBI and EBS are involved with alleged USD 634 million and USD 27 million, respectively, having found their way to accounts at the banks through the laundromat system. In both cases it is assumed that the banks failed to question who the real beneficiaries are behind the shell companies opening accounts and transferring vast sums of money, largely from the Lithuanian lenders. Additionally, Raiffeisen Zentralbank, which later combined with RBI, is said to have been a correspondence bank for one of the Lithuanian lenders involved in the scheme aiding with cross-border payments. The suit brought against RBI claims that the payments must have raised such significant red flags with employees and systems of the bank that the fact that the accounts were not reported immediately must be the result of criminal intent. We are not able to verify if that is the case. RBI will present its full-year 2018 results and hold a press conference next week Wednesday where we expect management to address these issues.