A report by the Danish law firm Bruun & Hjejle reveals a catalogue of errors, management failures, process deficiencies and negligence. There are even suggestions that some staff colluded and assisted with the illegal activities identified in the report.
Report on the Non-Resident Portfolio at Danske Bank’s Estonian branch
Depressingly, however, the report concludes that the CEO, chairman and Board of Danske Bank were not to blame – though the CEO, Thomas Borgen, has nevertheless resigned. Many have taken this to mean that the report was not conducted independently, and indeed as Bruun & Hjejle admits that it does other work for Danske Bank, this could be the case. But the real issue is the narrowness of the report’s scope. It makes little mention of Danske’s financial situation. As we shall see, this is a critical omission which badly undermines the report’s conclusion.
But first, how did this tiny Baltic branch of a Danish bank become the centre of possibly the largest money-laundering scandal in the world?
(L-R) Board member of Denmark’s largest lender Danske Bank Ole Andersen, CEO Thomas Borgen, vice-chairwoman of the board Carol Sergeant, board member Jorn P Jensen and attorney Ole Spiermann give a press conference about the money laundering scandal in the bank at the Tivoli Kongres Center in Copenhagen on September 19, 2018. (MADS CLAUS RASMUSSEN/AFP/Getty Images)
The origins of the problem lie in Estonia’s troubled history. Estonia was incorporated into the U.S.S.R. during the Second World War, and its banking system was integrated with Russia’s. But after the dissolution of the U.S.S.R. in 1992, Estonia found itself cut off from Russia’s banking system. It had to create a new system in a hurry, and like its neighbor Latvia it did so by means of a free-for-all in private bank licensing. One of the new banks created at this time was Eesti Forekspank.
Forekspank grew by expanding into Russia. By 1997 it had established branches in Moscow and St. Petersburg, and was accepting deposits from Russian customers as well as doing cross-border lending and foreign exchange.
Then came the East Asian financial crisis, followed by Russia’s default in 1998, which triggered a financial crisis in Estonia. To save Foreksbank from bankruptcy, the Estonian central bank merged it with another bank, Eesti Investeerimispank, to create what would be Estonia’s third-largest bank, Optiva Pank, in which the Estonian central bank had a 60% stake.
However, the Estonian central bank had no intention of hanging on to the bank it had created. It started looking for a buyer. And in 2000, it found one. The Finnish bank Sampo Bank bought Optiva Pank and renamed it AS Sampo Bank.
AS Sampo Bank continued much as Forekspank had done – building East-facing customer relationships and accepting deposits from customers in Russia and former Soviet states. By 2007, it had a substantial non-resident customer portfolio, of which a significant part was Russian.
In 2007, Danske Bank bought Sampo Bank in its entirety, including the Estonian subsidiary – and the problematic non-resident portfolio. According to Bruun & Hjejle, there was already a “red flag” about the Estonian business at the time of the acquisition:
In 2007, the Estonian FSA came out with a critical inspection report, and at the same time Danske Bank at Group level received specific information from the Russian Central Bank, through the Danish FSA. This information pointed to possible “tax and custom payments evasion” and “criminal activity in its pure form, including money laundering”, estimated at “billions of rubles monthly”.
But Danske Bank went ahead with the acquisition anyway. This was the first, but by no means the last, time that Danske Bank’s management ignored regulatory warnings.
AS Sampo Bank was never integrated into Danske Bank’s business. The Estonia branch, as it became, remained largely autonomous under its own management. In 2008, plans to migrate it to Danske Bank’s IT platform were shelved on grounds of cost.
Over the next few years, the Estonian branch’s non-resident portfolio grew, both in activity and in market share. By the end of 2013, it held 44% of total deposits from non-resident customers in Estonian banks (up from 27 per cent in 2007) and 9% of total deposits from non-resident customers in Baltic banks (up from five per cent in 2007). Most of these non-resident customers were companies, many of them shell companies registered in the United Kingdom.
This diagram leaves little doubt as to the principal purpose of the money flows through the non-resident portfolio:
Money flows through the Estonian branch of Danske Bank, 2007-15BRUUN & HJEJLE
This is what money laundering looks like. Note that sizable deposits came from Latvia and Cyprus, both of which are known to have been involved in laundering Russian money at this time. There is much more Russian money involved than just the 23% from Russia.
The Estonia branch management seem to have been negligent to the point of criminality. For example, this was their record on AML checks:
Assessment of AML checks carried out by the Estonian branch of Danske Bank, 2007-2015BRUUN & HJEJLE
Basically, they just didn’t do them.
But why were regulatory warnings about suspicious activity at the Estonia branch repeatedly ignored or watered down? Why did the concerns of a whistleblower fail to reach the Board?
Danske Bank’s press release suggests that the Estonia branch was so cut off from the rest of the Group that the Board could not possibly have known. Negative compliance and audit reports, severely critical reviews from Estonian regulators, and warnings from an executive in the Estonia branch were all either concealed completely or so watered down that they amounted to a conspiracy to deceive executive management. Even closures of correspondent bank relationships, which cut the Estonia branch off from U.S. dollar clearing, were not drawn to executive management attention.
I am not convinced. I suspect that Danske Bank’s management was suffering from wilful blindness. They did not know, because they did not want to know. And my reason for suspecting this lies in the accounts of Danske Bank itself.
After the financial crisis of 2007-8, Danske Bank was desperately short of money. It had taken huge losses on home loans in Denmark and Ireland, while shipping and other loans also turned sour due to global trade collapse. Loan impairments all but wiped out its profits in 2008 and 2009. Its share price collapsed from 270 DKK ($43.20) in February 2007 to less than 40 DKK ($6.40) in February 2009.
Then, just as it was beginning to recover, the Eurozone crisis clobbered it again. In 2011, profits halved and the share price, which had risen to 150 DKK ($24) in 2010, fell back to 78 DKK ($12.48). In 2012, Danske Bank was forced to raise $1.2bn of new capital.
But amidst all the gloom, there was one bright spot. The Estonian branch was consistently turning in brilliant results. It had very low credit impairments, a fast-growing deposit base and steadily increasing income. In 2011, it reported an astonishing 47% return on equity. Perhaps these remarkable results should have been taken as a warning: no above-board business could surely deliver a return on equity of that size. But for the beleaguered Danske management, Estonia’s success would have been a welcome relief: in the same year, return on equity for Ireland was negative189% and for Northern Ireland (U.K.), negative 88%, reflecting the terrible hit to shareholder value caused by the Irish property crash. Bruun & Hjejle’s report says that in 2011, the Estonian branch’s share of profits generated at Group level before credit losses and tax was 10.2%. I suspect this is too high, but the success of the Estonian branch’s money laundering business no doubt helped to shore up Danske’s profits as it absorbed enormous losses on other business lines. No wonder Danske Bank executive management didn’t pay too much attention to warnings about the Estonia branch’s activities.
The scope of Bruun & Hjejle’s investigation did not include a review of the financial status of Danske Bank itself or the concerns of management during the period in question. Had it done so, they might not have so readily exonerated Danske Bank’s CEO, chairman and Board of Directors. For although it may be fair to say that none of Danske Bank’s senior executives was directly responsible for what seems to have been criminal activity on a simply mammoth scale, all of them had motives for turning a blind eye to it.
The British philosopher John Stuart Mill once observed,
Let not any one pacify his conscience by the delusion that he can do no harm if he takes no part, and forms no opinion. Bad men need nothing more to compass their ends, than that good men should look on and do nothing.
At Danske Bank, money laundering on an unprecedented scale was made possible by the inactivity of those whose job it was to prevent it. Their claim that they could not have known is not credible. The CEO has already resigned; the chairman and the rest of the Board should follow. And there should then be an independent investigation into the culture that fostered and enabled the criminal activity at the Estonia branch, and the wilful blindness of Danske Bank’s executive management.
By senior contributor Frances Coppola
I write about banking, finance and economics. I used to work for banks. Now I write about them, and about finance and economics generally. Although I originally trained as a musician and singer, I worked in banking for 17 years and did an MBA at Cass Business School in London, where I specialized in financial risk management. I’m the author of the Coppola Comment finance & economics blog, which is a regular feature on the Financial Times’s Alphaville blog and has been quoted in The Economist, the Wall Street Journal, The New York Times and The Guardian. I am also a frequent commentator on financial matters for the BBC. And I still sing, and teach. After all, there is more to life than finance.
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