Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Moldova bank fraud challenges regulatory assumptions

There are many important and surprising lessons to be learned from the findings in the Kroll report on the bank fraud in Moldova. I believe that these have implications for regulators world wide.

The report is about the collapse in November 2014 of three of the largest banks of Moldova (Unibank, Banca Sociala, and Banca de Economii) which together accounted for 30% of the country’s banking sector. The missing money of more than $1 billion is over 10% of Moldova’s GDP.

There are three elements in the story:

  1. A surreptitious takeover of three of the largest Moldovan banks in 2012.

  2. Use of interbank markets and other wholesale sources by these banks to borrow large amounts of money so that they could lend more.

  3. Surreptitious lending of very large amounts of money to one borrower.

The crucial take away for me from the report is that it is possible to evade all the rules and regulations that banking regulators have created to prevent such actions.

For example, as in many other countries, acquisition of a stake of more than 5% in any bank requires formal approval from the National Bank of Moldova. However, shares in the banks were acquired by a large number of apparently unrelated Moldovan, Russian and Ukrainian entities none of which crossed the 5% threshold. All the entities had different addresses and do not seem to have common directors or shareholders. The Kroll report presents some circumstantial evidence that they are related based largely on the fact that they followed similar strategies around the same time and that some of the directors of these entities appear to be nominee directors. I do not believe that this could have been detected in real time. More importantly, I seriously doubt that an attempt to block the purchase of shares at that time on highly speculative grounds would have stood up in a court of law. I conclude that in a modern open economy, ownership restrictions are largely meaningless and unenforceable. They are mere theatre.

Turning to change of control, this too is not easy to establish even in retrospect. The weakest element in the Kroll report in my opinion is that it provides too little evidence that there was a major change in the management and control of the banks. In some of the banks, the management appears to have been largely unchanged. In some cases, where new senior management personnel were inducted, they came from senior positions at other large banks. It is difficult to see how the banking regulator could have objected to these minor management changes.

Finally, the fact that these banks lent such large amounts to money to one single business group (the Shor group) has become apparent only after extensive investigation. The analysis included things like checking the IP addresses from which online banking facilities were accessed by these entities. Media reports suggest that people in Moldova were taken by surprise when the Kroll report identified the Shor group as the beneficiary of massive lending by the failed banks. I am not at all convinced that regulators could have identified all these linkages in real time.

Finally, it must be kept in mind that the whole fraud was accomplished in a little over two years. Supervisory processes work far too slowly to detect and prevent this before the money is gone. I would not be surprised if much of the money left Moldova long ago, and the Shor group was just a front for mafia groups outside the country.

This example has made me even more sympathetic than before to the view that larger capital requirements and size restrictions are the way to go to make banking safer.


As an aside, the “strictly confidential” Kroll report was published in an unusual way. The report was available to only a very limited number of people in the Moldovan government because of the stipulation that:

Any communication, publication, disclosure, dissemination or reproduction of this report or any portion of its contents to third parties without the advance written consent of Kroll is not authorized.

The Speaker of the Moldova Parliament, Mr. Andrian Candu, published it on his personal blog with the following statement (Google Translated from the original Romanian):

I decided to publish the report Kroll and I take responsibility for this action. I do it openly, without hiding behind anonymous sources. … I understand the arguments of Kroll not to accept publication, but the situation in Moldova and our responsibility to be transparent with the citizens requires us to adapt to the realities of the moment … I think it is important that every citizen should have access to that report.

Every page of the published report contains the footer:

Private and Confidential: Copy 33 of 33 – Mr. Andrian Candu, the Speaker of the Parliament of the Republic of Moldova

This is about as transparent as one can get. Yet many sections of the media have described the publication of the report as a leak. I think the use of the derogatory word leak in this context is quite inappropriate. In fact, I wish more people in high positions display the same courage of their convictions that Mr. Candu has demonstrated. The world would be a better place if they do so.

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One response to “Moldova bank fraud challenges regulatory assumptions

  1. Pingback: In the sister blog during August 2015 | Prof. Jayanth R Varma's blog on computing

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