Money Laundering: Despite Reforms, Still a Tough Challenge for Ukraine's Banking System

BY VADYM SYROTA

The European Parliament experienced some unusual activity at the beginning of 2019. The attention of European lawmakers was drawn to cases of suspected money laundering through the Danish Danske Bank, with the potential involvement of Germany’s Deutsche Bank. The U.S. government also weighed in on events, sometimes expressing opposition to Europe’s anti-money laundering (AML) approaches, especially when they targeted allies and U.S. protectorates. When we take into consideration the earlier Global Laundromat scandal, which exposed a large money laundering scheme used by Russians close to the Kremlin and the security services, and the example of the Scandinavian Swedbank, one thing becomes obvious: the banking systems of both reputable European states and post-Soviet ones are actively being used to bring into legality the dirty money of the kleptocratic elites.

The economic system of crony capitalism, which has flourished in the post-Soviet space, functions through corrupt rents and nontransparent preferences. Local banks are widely used to legalize such ill-gotten funds and funnel them to safe harbors abroad. The next problem is whether to invest this money effectively or to use it to advance the interests of business tycoons and their government patrons’ political goals.

Ukraine has a permanent spot among the top ten countries on the Economist's crony-capitalism index. Unfortunately, Transparency International’s Corruption Perception Index confirms this situation: in 2018 Ukraine ranked below the index’s average of 43 points. At the same time, in the wake of the 2014 Maidan, authorities were pointing to the “success of the banking reforms.” A reduction in the scale of money laundering was hailed as one of the key achievements of the reforms. Without a doubt, during Viktor Yanukovych’s tenure as president, the banking sector was used to implement complex shadow schemes. Furthermore, Ukraine’s banking industry provided plenty of routes to funnel these dubious funds out of the country. Immediate and decisive regulatory actions were needed to turn the situation around. Unfortunately, the results were controversial.

In 2017, Ukraine’s banking market faced a new challenge. Rumors surfaced that Deutsche Bank was discontinuing correspondence banking with Ukraine's much smaller banks. Deutsche Bank’s decision to scale back banking activities in Ukraine is in line with the de-risking being undertaken by some leading global banks. The reduction in correspondence banking, a mechanism that unfortunately proved useful for laundering money, is intended to crack down on countries alleged to have “strategic deficiencies” in their AML regimes (such as the Baltic and Caribbean countries). The news that Ukraine’s banks were caught up in the network was a jarring note against the background of “success stories” in preventing bad banking that Ukraine’s regulator was reporting. Unfortunately, not only large global banks but also well-known international organizations noticed a certain regression of the Ukrainian financial system in the AML area. In 2013, the last year of Yanukovych’s presidency, Ukraine ranked 48 out of 149 countries on the AML Index, a rating scale designed by the Basel Institute on Governance.1 In 2018 the country did not manage to improve its standing: Ukraine ranked 39 out of 129 countries.

The case of Rosrakhunkoviy Center Bank suggests how variously money laundering can occur in Ukraine’s banking system. This financial institution serves as a central counterparty that executes settlements for the sovereign bond operations of local banks. Ukraine’s central bank, the National Bank of Ukraine (NBU), owns an 83.55 percent stake in this specialized bank. In April 2019 it was reported that the banking regulator fined this subsidiary for the improper conduct of AML procedures, and the CEO and top executive in charge of AML efforts were dismissed. Sovereign bond operations are one of the local ways in which the “shadow banking” industry operates. A plethora of illicit incomes are brought into legality through securities trading, which is characterized by enormous fluctuations in purchase and sell prices. High-ranking local officials and financiers are able to form an informal community aimed at generating profits through taking advantage of regulatory loopholes. Another striking example of such activity emerged from the investigation of the Al-Jazeera TV channel. The investigation brought under suspicion Valeriya Gontareva, the former head of the NBU after the 2013–2014 Maidan, who is thought to have laundered Yanukovych’s money through sovereign bonds worth U.S. $1.5 billion before the Revolution of Dignity.

In the AML context, Ukrainian banks are also vulnerable with respect to suspicious cash transactions, export-import transactions support, and banks’ treasury unit operations, mostly carried out without the actual delivery of currency or securities. Informally, market participants claim that the local banking regulator is inclined to abuse the agency’s power and apply fines and other sanctions discriminately. This is indirectly confirmed by the fact that the NBU has made a commitment to the IMF that it will phase out the current ineffective AML supervision procedures.

Actions that Ukraine is likely to take to improve the AML process include the creation of a public register of politically exposed persons, the design of a toolkit to prevent businesses’ use of shell companies, and the identification of local spots of shadow banking development, followed by regulatory measures aimed at mitigating risks when they do arise. Local business, for their part, may be stimulated to achieve greater transparency through improvements in corporate governance, better property rights safeguards, and the ability to access cheap funding resources. The Ferrexpo mining company (listed on the London Stock Exchange) is just the latest striking example of a company shouldering out-of-control losses due to suspicious activities. It should be noted that in the context of a considerable shift in the local political landscape, Ukraine’s western partners may have a positive influence in resolving money laundering issues and encouraging tighter banking regulation, thus depriving kleptocrats of a favored wealth-building mechanism.

Note:

1. The Basel Institute on Governance’s AML Index ranks countries from least effective AML procedures (first place) to most effective. For example, in 2018 Tajikistan ranked first, demonstrating the lowest level of AML procedures, while Finland, known for its zero tolerance of suspicious banking operations, ranked 129 (most effective AML procedures).