BaFin, the German Financial Intelligence Unit, responsible for supervising the banking industry in Germany, has come under a lot of scrutiny lately. A devastating article in the Wall Street Journal points out that the watchdog ignored warnings about Wirecard, the fintech company accused of financial wrongdoings, for ten years. Germany’s biggest banks, Deutsche Bank and Commerzbank, also seem to be in trouble a lot. But only outside the borders of their home country.
Yes, Germany has a reputation. Berlin has been dubbed the gangster’s paradise. The Italian mafia seeks out the city to buy real estate to launder money. While German lawmakers are attempting to put a stop to this by adopting the beneficial owner regulations of the 5th European Anti Money Laundering Directive, the question is: what are they doing about their banks?
Sparkasse: the bank that can’t be touched
Sparkassen are national saving banks and are very popular in Germany. Clients would rather pay more for the services of a Sparkasse than to open an account at a large institution such as Deutsche Bank. When it comes to money laundering, it is widely believed that the Sparkassen aren’t a real target for criminals. And surely enough, a Google search doesn’t come up with Sparkassen even being discussed for AML failings or discoveries.* This seems almost impossible since every bank will eventually have to deal with this problem. So, could the Sparkassen be overlooked in the fight against financial crime?
A Sparkasse usually is a small local institution without any international ties. That’s why it’s believed that the Sparkasse is less prone to being used for money laundering. But that doesn’t mean that there are zero risks of these banks being abused by criminals. In fact, a savings account and a checking account are among the riskiest financial instruments for money laundering operations given the ease with which these accounts can be opened and operated. Another reason for caution is that the worst behavior is often channeled through small institutions.
A possible scenario we can think of a savings bank being used for money laundering is channeling money to the real estate market. In the money laundering process, real estate’s role is to integrate black money into the legal economy. This phase happens after the placement and layering stages. The obvious signs of black money use in a real estate purchase are when someone pays cash or uses a complex loan. Given criminals’ tireless efforts to seek ways in which they can abuse the financial system, what’s the chance they would completely ignore the Sparkassen to layer their money? Because when a realtor receives a Sparkasse payment, they might overlook the possibility that they’re being paid with black money.
Why? Because although it’s rare for anyone to save up enough money to buy a house, it’s not unheard of. And given their excellent reputation and the prevalence of Sparkassen in Germany, it would make more sense for a large sum of money to come from a Sparkasse than from Deutsche or Commerzbank.
Wirecard could have happened anywhere
BaFin is being singled out now because of what happened with Wirecard. But it’s not fair to do that; they aren’t the only authority with problems. According to the recent Basel AML index, the deficiency of quality of AML frameworks is a significant problem in the European Union overall.
Honestly, among the European Union, Germany isn’t even listed by the US as a major money-laundering destination. That ‘privilege’ is held by Belgium, Cyprus, Malta, the Netherlands, Spain, and the UK. But does that mean that the Wirecard scandal was only an incident? Should we not worry about German supervision in general? Well, Germany hasn’t been reviewed yet by the Financial Action Task Force (FATF). That will happen in the fall of this year. So, until then, we can’t be sure.
But let’s look at the factors that cause ineffective supervision. These are:
1. Limited powers to sanction non-compliance by civil or administrative means.
2. Scarce resources, such as qualified staff, processes, IT-systems, and tools.
3. No Risk-based approach meaning supervision does not take into account the risks, and the size of the financial center and the number and intensity of reviews are not aligned with existing risks
4. Poor coordination of supervisory authorities, each authority solely focuses on its sector
5. Insufficient guidance on money laundering provided to reporting entities
Going back to BaFin and the Sparkassen. How do they do when measured against these points?
1. The German law does make it possible to give personal penalties to employees of banks that are in breach of compliance. But just like in other European countries, this isn’t done very often.
2. Scarcity in resources is a problem for BaFin, as it is for the entire compliance sector.
3. It might seem logical to classify Sparkassen as a lower risk. But is that truly justified? Although every Sparkasse is a separate entity, they are not isolated. They often collaborate. One way they do that is by making up a financial network.
4. Poor coordination of supervisory authorities is kind of what happened with Wirecard. The Wall Street Journal did say BaFin believed they were not responsible for the supervision of Wirecard. However, this would not be a problem with the Sparkassen because it’s clear that they are the responsibility of BaFin.
5. Generally speaking, the rules around money laundering are clear. But as we have stressed before, the rules change so often that it becomes confusing to most people. And that isn’t limited to the German laws.
Well, this assessment reveals a lot. Really, there’s no need for the FATF to look into Germany anymore… Ok, that’s a joke, but looking at the Basel AML Index, can any institution be safe for anti-money laundry?
Can’t be on a PEP-list but you can serve on the board
One thing that’s now being alleged in the Wirecard case is that they were affiliated with high-ranking politicians. Some of which were actively lobbying for them. The former minister of Economics was responsible for convincing Angela Merkel to promote Wirecard in China. This really goes to the top. But Wirecard isn’t the only company that holds political ties.
What’s striking about the Sparkassen is that local politicians sit on their boards. To give an example of a privilege, the Sparkassen have acquired through lobbying: they aren’t required to hold equity against their loans. A problem that has been ignored by German financial watchdogs for years because of political lobbying from the Sparkassen stated the Financial Times.
Granted, local politicians are probably not as powerful as the ones that were involved in Wirecard. Still, we have to ask: What influence does political lobbying have on how closely BaFin watches the Sparkassen’s compliance?
It seems contradictory to monitor transactions for politically exposed persons because they are a higher risk for involvement in bribery and corruption, but in the meantime allow them to be involved in what happens at the directory level of banks. Seriously, what’s up with that?
There are signs that Germany’s compliance framework isn’t as safe as it’s believed to be. Wirecard might not be the exception to the rule. Yet another sign of that is an analysis done by moneylaundering.com, which shows that German banks don’t file as many Suspicious Activity Reports as is to be expected given the size of Germany’s financial market.
To sum up the risks:
● Sparkassen aren’t the isolated institutions they are believed to be
● Involvement of politicians
● The Sparkasse products are risky in and of itself
● General quality of the AML framework in Europe is deficient
● Questions whether the number of SARs filed is proportional to the size of the financial market
So, are the Sparkassen at risk for money laundering? The truth is, no one institution is not at risk for money laundering. And isn’t it always better to be safe than sorry? In the end, poor compliance is detrimental to everyone as it undermines the trust in banks and the financial system as a whole. And although Sparkassen have a good reputation, it doesn’t take much for that to be thrown out of the window.
*In July 2020, Sparkasse of Malta was fined €217.635 for using simplified due diligence.