Hungary confronts the bankers of the underworld

Citation

Ország-Land, T. (2000), "Hungary confronts the bankers of the underworld", European Business Review, Vol. 12 No. 1. https://doi.org/10.1108/ebr.2000.05412aab.005

Hungary confronts the bankers of the underworld

Thomas Ország-Land

Thomas Ország-Land is an author and foreign correspondent who writes on global affairs.

Keywords Hungary, Law, Crime

Hungary has introduced landmark legislation against the thriving financial institutions of the criminal underworld. The experiment, variously described as brilliant, obvious and potentially effective, came into effect a little over a year ago. The earliest signs of its effects in weeding out dirty cash from the electronic transactions of the legitimate financial institutions are very promising.

The country has outlawed money-lending practised beyond a carefully constructed regulatory framework. This would deprive organized crime of its hold on many thousands of small businesses which have been hitherto abused for money-laundering operations with impunity. Hungary's neighbours throughout East Central Europe, whose police forces as well as financial and judicial institutions are undergoing radical reforms as the region painfully adapts to West European standards, are watching with enormous interest.

Most of them have already outlawed money-laundering and many them are about to widen the provisions of the law. For very sound economic reasons, the legitimate banks of the formerly communist-dominated countries of Europe have failed for the time being to meet the needs of small enterprises for start-up loans. This has created a business opportunity eagerly exploited by the Mafia.

But Hungary, which is the most advanced among its neighbours in the regional transition towards a market economy, now feels ready to clear its financial markets from organized loan sharks. Its success could help the entire region in the fight against financial crime.

"It is easier to rob a local bank than to persuade its manager to raise a loan for a new business", observes Laszlo Arva, an adviser of the Hungarian Privatization Research Institute, in a noted recent essay published in the authoritative daily financial newspaper Vilaggazdasag.

Even when a legitimate bank loan is available, the requirement for high collaterals places it beyond the reach of most entrepreneurs. By contrast, "organized crime demands a more easily insurable and more readily collectable deposit", Arva notes. "It is the life of the borrower."

In the absence of adequate credit facilities provided by the banks, organized crime is believed to have gained up to a 25 per cent share in the financing of the country's small and medium-sized businesses, effectively turning such enterprises into operations for laundering tainted cash. That proportion is probably much higher in other countries of the region.

The Mafia has also managed to infiltrate many legitimate financial institutions and to exploit its sophisticated electronic money-switching techniques for its own criminal purposes. And it has learned to fill many other needs neglected by the fledgling democratic institutions of the region. Struggling entrepreneurs are thus turning to organized crime for help in many areas - for example, collecting debts or protecting property - at a huge long-term cost to society.

"It is possible for someone's house to be sold out from under him because of the shortcomings of the land registry system", complains one Hungarian financial observer, "and it may take years of legal wrangling before the overburdened judiciary system can sort out a property conflict. Is it surprising then that many aggrieved parties ignore the courts and look to the Mafia for justice?"

Clearly, the Mafia is profiting from the transition process by temporarily assuming the role of the state which has been reduced in many key areas to be replaced by the emerging institutions of democratic society.

When they mature to fulfil their functions properly, these institutions may indeed leave little room for organized crime. In the meantime, it is essential to explore novel means to exclude criminal funds from the legitimate money market.

For the moment, however, criminal organizations throughout the region are increasingly investing in the transitional economies. Organized crime now controls nearly half of the Russian economy, according to conservative estimates issued by the Chief Prosecutor's Office in Moscow. The prosecutors estimate that 50 per cent of all commercial banks and 40 per cent of state-owned companies are criminally administered, thus affecting between 40 and 50 per cent of Russia's annual gross domestic product.

The destructive force of digital money in the hands of criminals is enormous, observes economist Douglas I. Keh in an important recent study. His analysis - Drug Money in the Changing World: Economic Reform and Criminal Finance, published by the United Nations International Drug Control Programme - will be considered very carefully by the law makers and law enforcers of Eastern Europe as they follow the success of the Hungarian experiment.

Keh considers the attraction of tainted cash to the region in terms of the profit opportunities created by the reduced lending volumes available from the legitimate financial sector. This leaves liquidity-strapped companies with only three options:

1. 1.

   to apply for government support;

2. 2.

   to trim business operations as well as profitability;

3. 3.

   or to seek credit from criminals.

In some countries of the region, the proliferation of organized gangs is even eroding the difference between legitimate and criminal banks.

"Crime syndicates have already infiltrated the financial system of the Russian federation", observes the Vienna-based UN organization in its companion study, Drugs & Development. "They are both the targets and vehicles for fraud, money laundering and extortion."

Criminal lenders enjoy huge advantages over their legitimate counterparts. They do not suffer the heavy cost of non-performing loans which burden the legitimate banks. They have the freedom to discriminate among borrowers, extracting the maximum amount of profit yield that can be collected from each.

In the legal credit market, laws prevent banks from charging different rates to individual borrowers based on customer-specific criteria. In the illegal market, however, such laws do not exist. The criminal lender can discriminate since he deals with his customers separately, they are desperate enough to pay almost any price, and the lender has the market power to exploit that willingness.

Criminal lenders can also use violence to ensure compliance with the terms of the loan. And by relying on personal contacts familiar with the business histories as well as the personal vulnerability of prospective borrowers, criminal organizations are able to minimize the volume of bad debt.

The niche exploited by the financial underworld has been created by unavoidable aspects of the change away from the rigid command economy of the bygone Soviet era. The reforms have led to a significant decline in bank lending during the past years, accompanied by very high collateral requirements and disturbingly high interest rates, implying lack of competition.

But these problems are likely to prove temporary in nature, says the Organization for Economic Co-operation and Development (OECD) in a timely recent analysis of the Hungarian economy. Hence the confidence of the Hungarian legal establishment to confront organized financial crime now that the transition of the banking sector is approaching its conclusion.

The OECD interprets the excessively high requirement for collateral set by the banks in terms of the underdeveloped mortgage market and the poor - although rapidly improving - maintenance of the national property registry. It views the bankers' exaggerated prudence in lending as a result of their recent experience with bad loans and their lack of expertise in evaluating promising new loan applications.

However, "the banks are increasingly seeking to expand their lending activities", conclude Andrew Burns and Giancarlo Perasso, the authors of the OECD analysis. Recent legislation on mortgages may also improve the access of individuals to legitimate seed capital. The time has therefore arrived to confront the criminal lending sector.

Most countries of the region are seeking improved international co-operation in conducting financial investigations, the creation of joint control units to analyse information and intelligence on money laundering and the implementation of training programmes for specialist staff.

These are the main components of the region's legislative approach to curbing financial crime:

• •

  establishing money laundering as a criminal offence;

• •

  introducing the mandatory confiscation of the financial proceeds of criminal activities;

• •

  preventing the abuse of the economy by organized crime;

• •

  promoting collaboration by financial institutions; and

• •

  providing mutual legal assistance.

But Hungary is going further. The Budapest reformers have changed the 1996 Finance Act to make big-time money lending without licence in return for profit or interest payments a criminal offence by itself, punishable by five years' imprisonment.

Lieutenant-Colonel Laszlo Pelikan, chief of the economic crime investigation department at Pest County Police Headquarters, described the law as a welcome and timely new weapon against the bankers of the underworld.

"Money lending is one of the most popular ways of making tainted cash grow", he explains. "We are talking of loans involving millions of dollars provided at interest rates up to 30 per cent - per week. Such loans usually lead to a whole lot of other offences like blackmail and violence against person and property.

"Yet we have had great difficulties in investigating the root cause of such offences because money lending, even at exorbitant rates, has hitherto belonged to the sphere of civil rather than criminal law."

The collateral identified in the contracts for such loans often includes the entire wealth of the borrower. A frequent ploy of the lenders is to manipulate the borrower, often by means of violence, into a circumstance in which he cannot meet his obligations in order to gain control of his home and business.

Geza Nadrai of the State Money and Capital Markets Directorate considered that the number of complaints generated by the unofficial financial sector had grown beyond tens of thousands during the past couple of years. The change of the criminal code may well lead to quick prosecution in many cases which in the past would have escaped sanction.

The reform has been made possible by progress in the transition process which the OECD believes is about to emphasize the importance of legitimate market agents, the private debtors and creditors, stockholders and banks, in the national economy. Success in the Hungarian experiment would augur well for the entire region in its fight against organized crime.