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The Baltic country is trying to attract fintech businesses through an open regulatory approach, but there is more to be done if the country wants to become the new home to global fintech.
Latvia has taken years trying to fix its reputation as a country with high money laundering risks, and is now looking for ways to attract more innovative financial businesses within its borders.
The authority responsible for licensing and supervising payment firms, for example, has taken a fintech-friendly approach, providing responsive and open dialogues with companies that aim to operate with a Latvian payment or e-money licence.
The Finance and Capital Market Commission (FCMC) argues it has changed its "tick-the-box" approach, which led to bank failures in the past, and is now choosing “quality over quantity” during its licensing process.
In addition, the country has put various measures in place to support new firms, including a new start-up visa for non-EU based companies. It has also adopted an attractive tax regime for start-ups offering a 0 percent tax rate when profits are reinvested and allowing fintechs to reward employees with company shares to attract skilled technology experts.
However, when it comes to payments, the key question is how easily can payment service providers (PSPs) offer their services?
First among equals
As a member of the EU, Latvia has, on paper, the same licensing and supervisory regime as all the other member states. In practice, however, there may be differences between countries as to how they interpret those EU-level rules.
In recent years, the FCMC has taken steps to become more transparent and communicate clearly with market participants through the release of guidelines and interpretations, Agnese Alaine, head of Licensing Division at the FCMC, said at a conference this week, discussing Latvia’s chances to become a global fintech hub.
The country has also improved its payments infrastructure and the FCMC is taking an open, fintech-friendly approach to attract new businesses in the country.
However, regardless of how approachable and responsive a regulator is, there is a more pressing issue that needs to be addressed if the country is to encourage more PSPs to set up in the country.
The licence itself does not have “much of a value without access to payment rails at the financial infrastructure”, Ivan Zhiznevskiy, managing director of payment service institution 3S Money, said.
PSPs suffer because they cannot connect to the infrastructure necessary to service their customers, Zhiznevskiy added.
Lithuania, which licenses the largest number of payment and electronic money institutions (EMI) among all the EU member states, became the main destination for fintechs in the EU following Brexit. It did so by opening up its central bank payments infrastructure to payments firms, which allowed fintechs to send and receive SEPA payments.
However, in Latvia, PSPs cannot connect directly with the central bank payments system. Instead, they must seek partnerships with banks that can enable them to access the necessary infrastructure.
Access for non-banks to payments infrastructure is becoming an increasingly important competition question that rule makers are grappling with around the world. In a recent interview with Payments Canada, a spokesperson for payments facilitator Square, said “expanding access is critical to supporting innovation and competition in the market”, highlighting the two year waiting time expected for new rules to be put in place in Canada, the spokesperson said its “a long time to wait for something that affects the lifeblood of a business”.
The situation in Latvia is exacerbated by the fact that local banks, which can provide indirect access to non-banks, remain overly cautious with PSP partnerships as a result of a reputational crisis that shook the country a few years ago.
The legacy of Latvia’s money laundering scandal
Confidence in Latvia’s anti-money laundering (AML) regime was shaken in 2018 when the US Treasury accused Latvian ABLV of money laundering and handling money for North Korean shell companies.
The scandal made Latvia take numerous steps to prevent such a fiasco from happening in the future. It replaced its bank regulator, AML regulator and central bank governor; froze assets; prosecuted suspicious shell companies; and initiated a series of criminal cases.
Although the country improved its reputation concerning its AML regime, the crisis had a longer-lasting effect on the country’s local banking sector.
Many banks are still afraid of managing risks, and even if they agree to consider a fintech partnership, they take a very cautious approach.
For example, Staņislavs Siņakovičs, head of sales and regional development of LPB Bank, noted his bank takes a very careful approach to new fintech partnerships. They carry out enhanced due diligence (EDD) to understand the fintechs’ KYC procedures, IT systems, risk management and onboarding processes. They hold interviews with people within and outside the companies to properly understand their business model and to make sure they are able to comply with the regulations.
However, this environment makes it very difficult for fintech firms to team up with banks and get access to the country’s payments infrastructure.
“Lots of participants, big and small, suffer because they cannot get themselves connected [with the payments infrastructure], either through central banks or through high street banks, and without this support, their service does not make any sense,” Zhiznevskiy said.
To help fintechs provide their services, regulators should encourage, or require, big banks to support fintechs, or at least communicate to banks properly that fintech partnerships are safe, Zhiznevskiy added.
Latvian banks tend to treat fintechs as high-risk regardless of whether they offer any high-risk products, he said. They go through all the processes that form part of the fintech’s business model to the smallest detail.
Meanwhile, other regulators encourage bank-fintech collaborations by making this process easier.
In Luxembourg, for example, the regulator released guidance stating that any financial institution licensed and regulated by an EU member state is considered low-risk because they have gone through the licensing process and are subject to an annual supervisory exercise, Zhiznevskiy explained.
Latvia could also look at the UK as an example, which has a regulatory approach focused on eliminating market entry barriers. Whereas in the EU, regulators do not let a business operate until they check their internal controls to the letter, the UK lets start-ups through the licensing process quickly, and later on, they delegate due diligence over to banks that are eventually responsible for connecting those start-ups to the payments network.
Latvian fintechs, by contrast, are overpoliced as they have to go through the high-risk, enhanced due diligence process of both the regulator and the banks, Zhiznevskiy pointed out.
Latvia, currently home to 15 PSPs and EMIs, accounts for a tiny portion of the total authorised firms in the EU. Although the country has taken many steps to attract fintechs, there are still various challenges that need to be addressed before the Baltic country can become the “new home for global fintechs”.
