As Lithuania, the financial powerhouse of the Baltic states, enjoys a wave of fintechs obtaining financial licences, recent years indicate regulators play a balancing act between fostering innovation and preventing financial crime through robust AML/CTF frameworks.
As Lithuania’s fintech market booms, despite numerous money laundering scandals in the Baltic states, one thing is certain; regulators will continue to tread the fine line between stepping up AML/CTF compliance measures, whilst also supporting an innovative ecosystem for start-ups. Lithuania’s fintech boom may just be a wave destined to crash for businesses ill-equipped to face the constantly changing compliance measures.
The Baltic laundromats
As the swathe of money laundering scandals swept through the Baltic states between 2010 and 2018, the post-Soviet vision of acting as a bridge between east and west appeared fanciful. If anything, the bridge allowed a syndicate of trojan horses to infiltrate Europe’s financial system under the guise of increasing international investment. The scandals exposed not only the region’s vulnerability to money laundering but also the weaknesses of the EU’s AML/CTF regulatory framework.
The widespread money laundering revealed the titanic failure of regulators and financial institutions to identify suspicious transactions. Swedbank’s three Baltic subsidiaries processed approximately $19 billion of suspicious incoming transactions, and $20 billion outgoing, between 2014 and 2019. In Estonia, Danske Bank also failed to detect money laundering, resulting in an estimated $200 billion in suspicious transactions flowing into the country, making it likely the largest money-laundering operation in history.
Similarly, Ukio in Lithuania became a crucial steppingstone for the Troika Laundromat, funnelling an estimated $4.9 billion out of Russia and into Europe. In 2018, Latvia’s third-largest bank, ABVL, went into voluntary liquidation due to systematic money laundering, which led to the circumvention of sanctions on North Korea. The following year, there were also corruption allegations against the governor of the Central Bank of Latvia.
In response, regulators re-evaluated their approach and placed the Baltic states under intense scrutiny to ensure they were better equipped to combat money laundering. Despite the goal of developing a global fintech hub in Lithuania, the country has struggled to swallow MONEYVAL’s medicine, being downgraded during the Enhanced Follow Up Report from ‘largely compliant’, to ‘partially compliant’.
As Lithuania courts fintechs via a throng of attractive measures such as tax rebates, as well as technical and legal cooperation, it also risks replicating the same relaxed AML/CTF compliance mistakes of the past. This is precisely why regulators at the intergovernmental and international level have hammered Lithuania’s on its head during their evaluations.
Lithuania emergence as a fintech hub
By 2019, Lithuania was enjoying its crowned position as the largest growing fintech sector in the European Union. Challenger banks, EMIs and FX have become increasingly prominent in Lithuania. More recently, the country is showing signs of becoming the new epicentre of govtech. Yet, of all the fintech niches, payments and remittances had been central to Lithuania’s burgeoning economy, accounting for 37% of the fintech sector in 2020.
How such a small economy outbid the rest of Europe reflects Lithuania’s flexibility of regulation for fintechs. It reduced the electronic banking licence application timeline to three months, whereas most European countries take twelve. Lithuania provided English translation for documentation, and for lending and payments companies it also lowered the minimum capital threshold to $1 million, whereas traditional banks require $5 million.
Yet, Lithuania has simultaneously been stepping up its regulatory framework for combating financial crime despite these ease of business measures. Lithuania became one of the first countries in the world to adopt the IMF and World Bank’s guiding principles for fintech regulation.
Marius Jurgilas, board member for the Bank of Lithuania notes this high wire balancing act, “Seeking to achieve a balanced approach, we maintain a supportive and open attitude to help foster innovation in the financial sector, while at the same time demanding strict regulatory compliance to ensure appropriate risk management.”
Even though the European regulatory focus is now on the innovators, the recent Wirecard scandal shows that the measures in Lithuania are still not enough to effectively curb financial crime. Like a broken record in a loop, this has been met yet again with increased pressure from regulatory bodies at the EU level for Lithuania to improve its level of oversight of the fintech sector.
Regulatory steppingstones towards a mature fintech ecosystem
The ebb and flow of financial regulation in Lithuania reflects its aim of developing an attractive ecosystem for innovators, whilst also maintaining efforts to impose strict anti-money laundering requirements. Developing a nuanced approach where regulations are proportionate to the size and risk of the company would be an important step forward for maintaining the longevity of the fintech boom.
Efforts such as the Bank of Lithuania’s regulatory sandbox, which allows start-ups to live test their solution in a controlled environment, whilst also allowing the bank to identify risks, is a promising development. Initiatives such as these that develop dialogue will help foster financial innovation while mitigating risk and regulatory shortcomings. Additionally, the newcomer programme is another promising initiative that promotes dialogue between regulators and new entrants to the market.
Fintechs overcoming the compliance burden with AI transaction monitoring
For the fintech sector, Lithuania’s flippant approach to regulation can be a major impediment for financially strapped start-ups aiming to scale their business, while also maintaining compliance. Too often, compliance measures rely on applying static transaction monitoring rules based on outdated risk typologies, which create a blind-spot as illicit actors continually adapt their modus operandi. The results of this process are costly and time-consuming as they require the manual assessment of large numbers of false-positive transactions.
However, budding innovative financial institutions in Lithuania, such as Mano.bank – a digital bank delivering easy access to financial products for both individuals and businesses, are now proactively addressing regulatory compliance measures by partnering with regtech companies using future-proof AI technologies. AI-powered transaction monitoring systems offer future-proof support helping fintechs remain compliant with the fast-paced regulatory landscape, at the same time accelerating their business growth. While Mano.bank's use of an AI-powered transaction monitoring system may make it an outlier today, AI-based solutions are already shaping the future of the industry.
If we can glean a lesson or two from Lithuania’s financial sector’s recent history, regulatory measures will continue to ebb and flow. Lithuania has developed its fintech sector largely due to the innovative approach taken by regulators to foster innovation, but the ease of gaining a payment institution license comes at a cost. Inherent in innovation are mistakes and blunders.
For young financial institutions to succeed they need to approach transaction monitoring compliance with innovative solutions that allow the flexibility to easily adapt processes according to the changing regulations. Technologies like machine learning are emerging as a path forward for fintechs aiming to scale their business, whilst maintaining regulatory compliance.
As Lithuania continues to cement its position as Europe’s fintech hub, quashing money laundering, will continue to be front and centre for regulators. For those unable to implement the right regtech solutions and keep pace with the changing AML/CTF regulatory environment, capitalising on Lithuania’s fintech boom may just be a mirage on the horizon.