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B A LT I C B U S I N E S S Q U A R T E R LY | A U T U M N 2018
BalticBusiness Quarterly W I N T E R 2018
26 | Waiting for Second Wave Fintech to conquer Europe 38 | Success Story From incubator to prestigios award 42 | Future of Business Best Baltic Startups
Fintechs are coming 22 | O L D vs N E W
www.ahk-balt.org
Myths busting about future of finances
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by ALEXANDER WELSCHER
Little Places, Big Money – and a dubious reputation First Latvia, now Estonia: The Baltic banking sector has recently been seriously shaken by new money laundering scandals. While they are by no means the first ones, these major cases are a blow to the financial sector and the image of the region. Or maybe not?
H
ardly anyone is likely to envy Karsten Dybvad for his new job. Only one day after his 62nd birthday, the current head of the Confederation of Danish Industry was nominated in November to be the new chairman of Danske Bank. Supported by the bank’s largest shareholders, Dybvad is set to take the helm as main supervisor at Denmark’s biggest lender, which finds itself at the centre of one of Europe’s biggest ever money laundering scandals.
Dybvad’s appointment came after an internal inquiry at Danske found that €200 billion in payments had been moved through its Estonian branch between 2007 and 2015. Of the approx. 15,000 accounts under investigation so far, some 6,200 are considered suspicious, according to the 87-page report published in midSeptember. In light of the money-laundering claims, the value of Danske shares plummeted to hit a year-low at the end of October, also because the bank is now the subject of criminal investigations – and could face hefty fines.
Cleaning up the Estonian laundromat The sheer scale of Danske’s dirty money scandal also cast a shadow over the financial system that acted as a gateway into the European financial system. What has happened in Estonia has kept the general public, policy makers, financial authorities and courts busy for months. Not least because of the vast amounts of money involved: The sum that flowed through Danske’s tiny Estonian branch via a total of around
9.5 million payments almost equalled the Baltic State’s GDP in the nine-year period under scrutiny. In addition, there are also suggestions that some of the local staff colluded and assisted with the illegal activities identified in the publicly available report. The revelation and related media investigations have sparked heated discussions over whether the supervisory authorities – in spite of vast amounts of evidence – have been too slow to react and the applied measures were sufficient. The European Commission has called for a probe into the regulatory failures and chided Denmark and Estonia over failing to completely enshrine the fourth EU anti-
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money laundering directive into national law. Often regarded as one of the most exemplary members of the EU and euro zone, the dirty money scandal might be a serious backlash for Estonia’s financial system and cause problems of both a prestigious and political nature.
Photo: Alexander Welscher
“Estonia has definitely lost credibility here”, says Morten Hansen, head of the Economics Department at the Stockholm School of Economics in Riga. His stance is echoed by Jan Körnert, professor of economics at the University of Greifswald with a research interest also in the Baltic banking sector. The German academic, however, sees the money laundering scandal more as an “industry-specific issue”
with a more direct negative impact on the reputation of the banking sector and Danske. Körnert believes that outside financial circles, the scandal might have even remained unnoticed in large parts of the population of unaffected Western European countries such as Germany.
Something is rotten in the state of Denmark – or Estonia? While the Danish government and central bank have stated the scandal risks damaging the entire country’s reputation, the money laundering incident has so far drawn mixed reactions in Estonia. For ErkI Kilu, head of the Estonian Banking Association, the Danske case has badly
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amount of damage here compared with other countries where the very same problem exists”, claimed KatrI Raik, director of the Estonian Foreign Policy Institute at the International Center for Defense and Security, at a discussion in the Estonian parliament. In her opinion, the international focus is rather on Danske Bank, Denmark and the phenomenon of money laundering in general. Similarly, the Estonian daily EestI Päevaleht referred to a popular saying from Shakespeare’s famous play Hamlet: “Something is rotten in the state of Denmark”, it wrote in an editorial.
Latvian banking sector in hot water
The Baltic states are considered a single market. Therefore, we cannot ignore what is happening to the north of the Lithuanian border. Vitas Vasiliauskas, governor of Lithuania’s central bank
damaged Estonia’s banking reputation, while former Estonian President Toomas Hendrik Ilves, whose tenure ran almost synchronously with the laundering scandal, laments that his country is being made the scapegoat. He told the Danish paper Weekendavisen that Estonia did its job in supervising the bank activities but now is a very convenient fall guy for the Danish lender in the whole affair, since it fits the narrative of a little Eastern European country that does not control anything. Others see the money laundering scandal less of a blow to Estonia’s international prestige. “I would not be too concerned now that Estonia has experienced a significant
One of these other countries mentioned by Raik is right next door. Being the regional financial centre, neighbouring Latvia has seen several banking scandals in the last couple of decades. Only few of them, however, have shaken Latvia’s financial system like the ones that evolved in early spring this year. With ABLV, one of the biggest lenders went into selfliquidation after U.S. authorities accused it of having “institutionalized money laundering as a pillar of the bank’s business practices” and sanctions busting by helping to finance North Korea’s nuclear weapons programme. Separately, the country’s central bank chief and ECB policy maker Ilmars Rimševics was suspended from his post and faces criminal proceedings due to corruption suspicions. In a case without precedent, repercussions from the scandal are also being felt at the ECB, which asked the European Court of Justice to clarify whether Latvia violated EU law by enforcing security measures against its council member Rimševics before the end of the criminal proceedings. Both cases have caused considerable turbulence that could damage Latvia’s standing in the euro zone and its credibility as a financial hub. “It is clear that much has happened this year and that the reputation of the financial sector has been significantly affected”, Reinis Rubenis,
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withdrawn some years ago. The latter now also features in new accusations of money laundering of up to $405 million against Nordea Bank that are supposed to have been moved to the lender via Danske’s Estonian branch and Ukio Bankas. Unlike Latvia and Estonia, the Lithuanian banking system still has access to US dollar correspondent banking.
Tempting lure of easy money
What was there left to harm? How much lower could we get? Morten Hansen, head of the Economics Department at the Stockholm School of Economics in Riga
Photo: Kaspars Garda
CEO of Swedbank Latvia, told the Latvian news agency Leta. Even though Latvia’s biggest bank is not drawn into the money laundering scandals that have tainted some of its peers, the retail bank still feels the consequences of recent events. “There is no direct impact on Swedbank, but the reputation risks, of course, are leaving their mark.” The wave of negative press in the international media seems not just to have spill-over effects on individual banks in Latvia and Estonia, but also in Lithuania. “The Baltic states are considered a single market. Therefore, we cannot ignore what is happening to the north of the Lithuanian border”, Vitas Vasiliauskas, governor of Lithuania’s central bank, told the main Baltic news agency BNS. “All these actions affect the reputation of the Baltic states’ banking sector one way or another.” However, it must be said that Lithuanian banks are no strangers to controversy either, with Snoras and Ukio Bankas having their banking licenses
The new major scandals have raised further preexisting questions about banking practices in the Baltics. In all three countries, the commercial banking sector is mainly dominated by domestic clients serving Nordic banks alongside a number of privately-owned local lenders that act as a gateway for cash from Russia and other CIS countries by offering Swiss-style confidentiality. For a long time, concerns have centred on these boutique banks’ push to cater to these so-called non-resident clients – an issue often highlighted as a source of risk by international authorities but long ignored by local supervisors. The specialisation in flexible and secretive financial services has grown to become a lucrative multibillion-euro business. The sector flourished especially in Latvia which earned a dubious, partly self-imposed reputation as the Baltic Switzerland, while in Estonia and Lithuania the non-resident catering did not develop on such a large scale. Even though many of the deposits were perfectly legitimate, the line between legitimate non-residential business and money laundering seemed to be thin. “Many local banks simply have not been able to keep their hand out of the cookie jar.” This is how the economist Hansen explains the numerous money laundering scandals that Latvia, in particular, has witnessed. Given previous egregious incidents, the latest illicit money case with ABLV for him does not have much of an effect on the reputation of the Latvian banking sector. “What was there left to harm? How much lower could we get?”. Hansen cynically highlights the big
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It is essential for the Latvian economy to reduce risks in the financial sector. Determined action from all involved institutions will increase the reputation of the Latvian financial sector Mārtiņš Kazāks, board member of Latvia’s central bank challenges facing the Baltic state in repairing its tarnished image. “To those who deal with it, Latvia was already known as being rather dodgy in sections of the banking system. Not all of it – and this is important”, he underlines, in reference to the retail banking system.
Blowing the whistle on money laundering In the wake of the Danske Bank scandal and ABLV’s forced collapse, financial watchdogs in Tallinn, Riga and elsewhere are now stepping
Photo: Kaspars Garda
Being now a board member of Latvia’s central bank, Martiņš Kazāks is more diplomatic in his assessment. For him, the ABLV case has “undoubtedly had some impact” on Latvia’s reputation as a financial and banking centre. Similarly to Hansen, the former chief economist at the Latvian subsidiary of Swedbank sees it
as an “industry-specific issue of quite a few banks”. Kazāks stresses that the risks have been contained and did not spill over into everyday economic activity or affect overall financial stability, and he points to the rather weak links between the non-resident client banks and the wider domestic economy.
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up their scrutiny of banks’ dealings with their customers. First and foremost, US authorities have built up relentless pressure to make the regulators start seriously clamping down on the stream of dodgy millions from the East. One of the main reasons for this is the heightened tensions between Russia and the West. “Geopolitics and the interpretation of anti-money laundering and counterterrorist financing have changed”, Kazāks explains. Worries have increased that shadowy banking activities can assist those looking to evade sanctions or finance terrorism. After years of massive illicit flows and international criticism of lax controls, the Latvian government has now finally committed to reducing non-resident banking drastically. In record time, action was taken to strengthen the supervision and long overdue efforts to clean up the sector – with the aim of reducing the dependency of the financial institutions on dubious cash sources from non-EU countries and eliminate the associated problems of money laundering and sanctions busting. Whether the much hyped improvements will materialise can only be seen next year. What is undisputed amongst local experts and international observers is that the further development of the banking sector will mainly depend on how successfully the government implements the recommendations of Moneyval, the anti-money laundering body of the Council of Europe. Being already subject to an enhanced follow-up procedure, a negative evaluation in 2019 could result in Latvia being blacklisted as a noncompliant jurisdiction. „It is essential for the Latvian economy to reduce risks in the financial sector. Determined action from all involved institutions will increase the reputation of the Latvian financial sector“, emphasizes Kazāks. „It is by no means easy, but these changes should have a positive long-term impact both for the financial sector and overall economic growth.“
Situation and reputation not as bad after all? This possible worst-case scenario and other uncertainties have not prevented US private equity fund management company Blackstone from investing €1 billion in Luminor bank, the third largest financial services provider in the Baltic banking market. For many industry experts, this decision is proof of the confidence in the region and its economic potential, which was also confirmed by international rating agencies. In generally upbeat assessments, Fitch reaffirmed Latvia’s ‘A’ rating in October and upped Estonia’s rating to ‘AA’. The scores achieved by the Baltic States in the Basel Anti-Money Laundering Index 2018 were similarly positive. Despite the Danske scandal, Estonia is even considered to be the country with the second lowest risk of money laundering and financing terrorism in the world, according to the independent annual ranking. Lithuania ranks in third place, while Latvia comes in at 14th. Whether this will impress Danske´s new chairman Karsten Dybvad remains to be seen. In late April, the Danish lender declared it would align its remaining Baltic operations with the aim of focusing on customers in the Nordic region, especially in its home market. Prior to that, it sold its retail operations in Latvia and Lithuania back in 2016. It is not yet clear what will happen to the scandalridden Estonian branch that Danske acquired when it made its move into Estonia in 2007 by buying Finland’s third-largest bank Sampo. In any case, it appears that it will take time for the dust to settle for Danske Bank, and to restore credibility and public confidence. Asked by the Danish business newspaper Børsen what his primary task as new chairman of the scandalridden bank will be, Dybvad answered that his main job will be to restore one thing: trust, trust and once more trust. The same goes for the Baltic banking sector. It is not an easy task.
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by ALEXANDER WELSCHER
Banks vs Fintechs!? Banks can pack their bags because fintechs will reign the world very soon. There will be only technologies in world of finances. Fintechs are just a current fashion thing that will soon end like Yoyo or Pokemons. We asked three experienced Baltic banks and three fast-growing fintechs what they think about urban myths regarding future of finances.
Photo: shutterstock.com
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Banks
Fintechs
IEVA VĪGANTE
KĀRLIS DANĒVIČS
SLAVOMIR MIZAK
ROLANDS MESTERS
LARS TRUNIN
ROBERTS LASOVSKIS
SWEDBANK LATVIA Head of Corporate Customer Division
SEB LATVIA Board Member and Head of Credits and Risks
CITADELE Member of the Management Board
NORDIGEN CEO
TRANSFERWISE Product Manager
TWINO Investnent platform Lead
FinTechs are the ultimate end of traditional banking IEVA VĪGANTE: Fintechs are not the only ones who are responsible for the business model changes in the traditional banking industry. The digitalization and tech innovations reshape the financial industry. Customer needs and expectations towards banking services are growing. The proliferation of mobile devices, the increase of fintech firms, the patterns of new generations are the driving forces in this development, fuelling the emergence of new financial products that better address customer needs by increasing accessibility, speed, and convenience. I’m convinced that it is surely not the end of banking, but it will definitely change the way the banks work. It is about creating an ecosystem and decreasing frictions in the customer’s shopping process with the help of Open Banking platform. KĀRLIS DANĒVIČS: Definitely not. Rumours about the death of traditional banking are grossly exaggerated. One thing that we find will be particularly difficult to copy is through-the-cycle risk management and ability to create so much so called broad money (M2X in Latvia). Banks take on a lot of deposits and recycle them in loans in a surprisingly efficient way (the trust level is hard to copy, while the level of equity is rather moderate that is used). SLAVOMIR MIZAK: Traditional banking how we knew it from some years ago is changing rapidly mainly because of smartphones introduction, steep increase in their penetration and usage and digital transformation which is happening in every industry. Financial services industry is changing also with the new technology, digital innovations and new user experiences introduced by the FinTechs. Competition in every industry is good. It boosts the innovation and brings benefits to the customers and the industry as such. FinTechs are threat to old fashioned legacy banks which are not innovating
and adjusting to the new digital era. Those banks who embrace it will benefit from ongoing customer trust and strong position in the financial system. LARS TRUNIN: Financial technology companies are setting new standards for the consumer experience. By replacing old payment rails with new, superior infrastructure, we’re delivering faster, cheaper more convenient services. Banks have been overcharging and under-delivering for lots of services for years, so a shake up of the industry was badly needed. That’s what fintech is bringing. ROLANDS MESTERS: FinTech companies and particularly startups are able to leverage the latest technology to conquer specific niches and deliver value to end-users much faster than traditional institutions. Nordigen is proof of this - our account analytics solution is already delivering better, faster and more scalable results for banks and alternative lenders worldwide. The flexible format of a FinTech startup has allowed us to build our platform within a years time, whereas a more bureaucratic institution, such as a bank might achieve the same result within 2-3 years. That being said, the biggest beneficiaries, in this case, are the traditional banks as they can cooperate with startups to leverage their innovations to offer better solutions to the end-users. ROBERTS LASOVSKIS: FinTech are new era for traditional banking. Considering the innovation and the speed that fintechs bring to customers and industry itself, banks will have no choice but to start focusing on their innovation strategy more seriously. Yet, it is very likely that a successful innovation strategy and its introduction will heavily depend on effective collaboration with the fintech sector.
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FinTechs are just a bubble destined to burst and essentially nothing else than old wine in new bottles IEVA VĪGANTE: Fintechs started to emerge after the financial crisis in 2008. The development of fintechs in the last 5 years was mainly influenced by technological advancement, API opportunities, changes in regulation and the reducing barriers in the EU market, new patterns in consumer behaviour as well as new ways for start-ups to access the funding. The French project “ZeBank” in 2000 is a very good example to explain why only lately fintech companies have started to grow. At that time their goal was to develop the new type of bank and they invested more than 150M in the bank’s infrastructure, licensing and operations. After seven months of struggle, the start-up went bankrupt. Comparing to the situation 10 years ago, nowadays it is much easier to start and run the fintech company. KĀRLIS DANĒVIČS: Not true either. I think that one crisis later we will know which FinTechs will survive. My bet is that 1/3 will remain and will evolve into something meaningful. Some might even challenge the banks as digital media challenged printed press – e.g. in payments, cards etc. products they might scale up globally in a very fast manner.
SLAVOMIR MIZAK: FinTechs have their place on the market. They brought disruption, are bringing a new way of how financial services could work, found a way how to serve unbanked and underbanked population, how to increase convenience and improve customer experience. FinTechs helped to shape and change the banking experience. Today we see increasing list of FinTech unicorns which is a result of strong believe, trust and positive expectations from the investors. The challenge for them is to get a scale and sustainable business model in the highly regulated area. Time will tell us what long term place will FinTechs find in the financial system. LARS TRUNIN: But that doesn’t have to mean the end of traditional banking. Banks that embrace this movement can take advantage of partnership opportunities with fintechs to offer new technology solutions, faster. At TransferWise we’re agnostic about how customers get access to our service - whether directly through our app, or through a convenient partnership with their existing bank such as BPCE, Monzo or N26. The important thing is that our technology reaches the people who need it. ROLANDS MESTERS: On the contrary - according to FinTech global, 2018 has already been a record year for global FinTech investment, with global FinTech sector raising $41.7bn in the first half of 2018, surpassing last year’s record total. Investment also skyrocketed in Q2, setting a new quarterly funding record. ROBERTS LASOVSKIS: The nature of the financial industry now can be described as rapidly evolving and changing. To be successful in such environment, you must be evolving and changing yourself.
FinTechs are not secure and can never reach the same level of customer trust as traditional retail banks IEVA VĪGANTE: What we see from the Wise Guys Fintech accelerator program hosted by Swedbank, the vast number of fintech companies are reaching out to business customers rather than the end users. Therefore, it is very much about re-defining the term of trust in a traditional sense. KĀRLIS DANĒVIČS: One crisis later it is clear that there will be many disappointments and
also regulator will step in to help FinTechs regain trust. More trust will come but so will more costs. SLAVOMIR MIZAK: People in general like convenience, better user experience in their daily life however when it comes to their own money and savings they want to keep it at the first place safe with the trustworthy institutions. Financial services is the industry
built on trust of the customers. It is highly regulated industry and after financial crisis the regulations are stricter and supervision stronger. We cannot generalize whether FinTechs are or are not secure. However, to gain and maintain the trust of the customers it is important, for FinTechs similarly as for the banks, to focus on security, privacy protection and compliance with regulations.
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FinTechs and banks are locked in a fierce battle and their relationship is purely competitive IEVA VĪGANTE: Banks tend to shift toward viewing fintechs as collaboration partners as competitors or disruptors. Collaboration between banks and new players is already taking place. We see that the banks are increasing their investments in the fintech sector through acquisitions, accelerators, incubators, investment funds etc. For example, Swedbank hosts fintech companies already for the second accelerator program Wise Guys Fintech in Riga with a very good success rate. KĀRLIS DANĒVIČS: Not from where I’m standing. On one hand, banks have a lot of money, many clients, but are inert and are not able to risk and work in an agile manner. For FinTechs it is exact opposite of all those statements. So banks and FinTechs make a perfect match (if egos can be put aside). SLAVOMIR MIZAK: The relationship between banks and FinTechs is both competition and collaboration. Naturally both are fighting for the same customers. On the other hand, many FinTech startups are funded or co-owned by the banks and many top ex-bankers are behind successful FinTechs. Also many banks are adopting new technologies, undergoing digital transformation inspired and fuelled by FinTechs and they cooperate with Fintechs by using their innovative services, offerings and technology. In my opinion further cooperation and collaboration between startups,
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FinTechs and banks will be beneficial to everybody mainly for customers and the whole financial services environment. LARS TRUNIN: The European Parliament’s Cross Border Payments Regulation will make it harder for Estonian banks (and all others in the EU) to continue the outdated practice of hiding fees from customers in a poor exchange rate. The regulation will make it easier for customers to compare costs between fintech international payment providers and traditional banks. That means better, more informed choices, and extra €4 billion that go back into the consumers’ pockets instead of banks’ pools of profit. ROLANDS MESTERS: Not necessarily. While competition is the driving force behind progress and innovation, the ‘race’ will definitely be won by companies that collaborate and achieve a win-win-win scenario for FinTechs, banks and most importantly - customers. ROBERTS LASOVSKIS: In the following years, we will see more and more active cooperation between the both sides, including banks acquiring fintechs. Traditional banks often attribute the success of alternative lenders to loose regulation and complain that bank licences reduce their flexibility and give Fintech an unfair advantage. However, banking licences also have a decisive advantage: the possibility of operating freely within the EU. What we see as a bigger threat to existing players in the global bank sector, both traditional and newcomers, is tech giants. These companies already now have great financial resources and extensive client base. For example, if Facebook successfully converted only 1% of its users to bank clients, it would automatically make this social media into one of world’s largest banks based on client base.
LARS TRUNIN: Regulators are starting to create opportunities to level the playing field between banks and fintechs. For instance, the Bank of England this year allowed nonbanks access to their settlement system that enables them to have direct access to the Faster Payments Scheme - a huge win for fintechs who had previously been slowed down by retail banking middlemen as well as for consumers and small businesses who will benefit from lower fees.
model is often built around delivering just one service really well. In reality, the newcomer status of every FinTech company requires it to adhere to the same regulations that bind traditional retail banks. In order to receive access to any bank’s API, a FinTech company must first be secure and compliant with the regulation. On top of this, numerous fintechs, including Nordigen, have received additional ISO 27001 certifications to follow the industry security standards.
ROLANDS MESTERS: Whereas a bank offers a wide arrange of services, a FinTech company’s entire business
ROBERTS LASOVSKIS: In fintech, to be successful, your business should constantly be looking for ways of
growth and development by means of innovation and change. You find a potential improvement in your service or product, next you strive to find new and better way to fix it. When it’s done, you look for the next one, it’s a neverending cycle of improving, change and growth that makes you the best option for the customer and a step ahead of your competitors. Such approach requires taking risks, introducing the unknown always comes with it – and success is when your fintech is powerful enough to take these risks again and again. Fintechs sure are risk takers, but not all are powerful enough. This should be changed. Winter 2018
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