Fund Transfers from Russia to Italy:

An Interpretative Framework.[1]

Structure of the report:

  1. Introduction. 3

i.Research approaches to the analysis of international capital flow.3

ii.Methodology and sources of information.4

iii.The Bank of New York affair.5

I.Fund transfer from Russia: goals, channels and methods of struggle.8

  1. The definition of the problem.8
  2. The current situation in the Russian economy.10
  3. The goals of fund transfer.13
  4. Channels and techniques used for fund transfers.18

4.1.Receipt of the Central Bank’s permission.19

4.2.Pretended transactions.21

4.2.1.Import of goods on terms of prepay22

4.2.2.Export of goods on terms of pre-delivery22

4.2.3.Overcharging/undercharging of price of a contract23

4.2.4.Overcharging of the fines23

4.2.5.Contract on rendering of services23

4.3.Offshore companies.23

4.4.Crediting foreign firms. 25

4.4.1.Non-return of the credit.25

4.4.2.Overcharging the credit interest rate.25

4.5.Usage of lacunas in currency regulation.25

4.6.Funds transferred in cash.26

4.7.Financial instruments.27

4.8.Other channels of fund transfers.28

  1. Methods of regulation of fund transfers.29

II.The role of legal, extralegal and criminal operators in the utilisation of the different channels and techniques. 32

  1. The criteria of differentiation of legal, extralegal and criminal operators of fund transfers. 32
  2. Definition of legal, extralegal and criminal operators.33
  3. Analysis of operators’ actions in critical situations.34

8.1.Making contract.36

8.2.Involving the relatives into the business.40

8.3.Making business in Italy.42

  1. A methodology for determining the nature of the funds transfer’s operators.44
  2. The factors which explain the choice of channels and techniques of fund transfers, and the characters they have. 45

Supplement.

0.Introduction.

i.Research approaches to the analysis of international capital flow.

Nowadays we observe the widening interest of international community to the question of functioning of the international financial market. This interest could be explained by the process of globalisation implying the rising dependency of national economies upon the international financial market.[2] The international financial market have a complex structure, it includes three segments: legal (financial transactions made in the legal framework), extralegal (transactions are made outside of the legal framework) and criminal (transactions are made by violating the Law). Consequently, globalisation of the financial market could lead to the spread of extralegal and criminal economic activity through the national frontiers. The recent investigations on the nature of the capital flow through the Bank of New York accounts and initiatives taken by members of the G-7 in the field of regulation and control of the international capital flow illustrate this danger.

The evaluation of the nature of the international capital flow represents a complex theoretical problem. The number of publications on this problem growing, but most of them are based either on the journalistic investigations, or on the traditional theoretical approaches: economic, legal, statistical, political. It should be mentioned that the problem lying on the intersection of different spheres by definition can not be resolved by an one-dimensional approach. This is why we have decided not to remain in the framework of any one-dimensional approach. The composition of our research team: an economist, a political scientist, a sociologist, a lawyer, allowed us to develop an interdisciplinary approach. So, the specificity of the presented research consists in trying to work out an interdisciplinary analysis of the nature of international capital flows. The institutional economics, especially French theory of conventions (L. Thevenot, O. Favereau, A. Orlean), provided us with the theoretical basis for such multidisciplinary view.

The absence of a single and recognised by all scholars approach explains the difficulties with quantitative estimations of the capital flow through the national frontiers, - the quantitative description is usually the first step in the research. For example, there are several approaches allowing estimating the volume of capital coming on the international financial market from Russia. This explains why during the period from 1992 to 1998 the volume of capital transfer according to different sources varies from $40bln to $400bln. The minimum level - $40bln. – has been done on the basis of the balance of payments (capital transfers are mainly reflected in account «Net errors and omissions»).[3] The maximum level - $400bln.- has been done according to data of the General prosecutor’s office and Ministry of Interior (MI), which concentrate on the real estate that was bought by Russian citizens abroad.[4] Between these two extremes there are several figures: $230bln according to the Ministry of Economy (ME), - $130-$140bln for CBR,[5] $150bln according to a group of experts,[6] - $50-$60bln according to the World Bank and Paris club,[7] $130bln according to the international business consulting agency (IBCA) “Fitch”.[8]

We can so consider reasonable an average estimation of capital transfer made till the beginning of 1999 of about $150-$200bln. The time-series data shows that the dynamics of fund transfers is not steady. For example, according to MI, the peak of fund transfer - $30-$35bln per year – was in 1993-1994 (see the chart)[9]. At present it is $9-14bln. per year. In Ministry of Finance and Ministry of Economy they think that now the volume is $1-1.5bln per year.[10]


ii.Methodology and sources of information.

The interdisciplinary approach requires the choice of an appropriate methodology and sources of information. The institutional economics first at all analyses the incentives created by particular institutional environment. Otherwise stated, in order to investigate into the nature of capital flow from Russia, legal, extralegal or criminal, we have to analyse the incentives to economic and financial activity created by the institutional environment in Russia. Such analysis would enable us to construct “ideal types” (in Max Weber’s terms) of legal, extralegal and criminal behaviour. It is important to note that these ideal types are built upon behaviour in many situations, including purely economic behaviour and other aspects of the everyday behaviour. The analysis of incentives and behavioural patterns necessitates the use of a large variety of sources. We have tried to combine sources with different nature: economic, sociological, juridical, political.

The sources used in this report can be divided in six main groups:

Mass media. While preparing this report information data banks of the Central Bank of Russian Federation (CBR) and Federal Tax Police Service (FTPS) were used. These data banks mostly include publications in newspapers, journals and special editions concerning the problem of fund transfers. The statistics about the different types of criminality connected with the money laundering (Art. 174 of the Penal Code of Russian Federation) and the fund transfers was also available. Altogether there were processed about 500 sources including publications in special editions (Expert, Kommersant [Merchant], Dengy [Money]), in central and regional mass media, and materials of special monitoring TV and radio programs;

Official documents (instructions, orders) and analytical materials of the CBR and FTPS. The general overview of the normative documents issued by the CBR in the field of fund transfers has been made. The list of these documents is given in the Supplement. In the same time, there have been analysed the CBR procedures of issuing the permissions for the legal fund transfers.

Interviews of experts. In the report the results of structured in-depth interviews with four experts from CBR and one from FTPS, were used.[11]

In-depth structured interviews with entrepreneurs, including those who have business contacts in Italy. During the period from November 1998 to July 1999 31 interviews with entrepreneurs of different level – petty, middle, large - were carried out, including 8 interviews with people, who were convicted for economic offences. All these entrepreneurs belong to following sectors of economy: 9 of them work in banks,[12] 5 - in trade and production of furniture, 3 - in shops of souvenirs and ceramics, 2 - in production of ventilating systems, and 2 - are shuttle traders. The structure of the questionnaire as well as the short characteristic of each interviewed person are presented in the Supplement.

Sociological survey of Russian entrepreneurs. The poll was carried out in June – July 1999 among 174 entrepreneurs, residents of 8 Russian regions. Among the respondents 21% are the directors of small companies; 57% of middle companies; 22% of large companies. The detailed description of the sample and the results of the survey are given in the Attachment.

  1. The Bank of New York affair.

The work on this report has coincided with a series of international scandals connected with the Bank of New York. Although the situation with this affair is still not clear, and the diffused information is far from being correctly analysed and proved, we should emphasise that our findings do not contradict this new information which has not been known at the beginning of our research.

The information about suspicious transactions in the Bank of New York (BONY) has firstly appeared in August 1999. In particular, there were strong doubts about the origins of 100,000 transactions made by three corporate clients of BONY, Benex International, Becs International и Torfinex. The total volume of funds transferred through the accounts of these three firms was evaluated in $4,2 milliards (since October 1998 till March 1999). There were some signs persuading that some of these capitals have criminal origins.

More careful analysis has showed that the really criminal capitals represent only a small percentage of these milliards. For example, it has been proved that $300,000 of redemption for the Russian businessman Edward Oleminsky have been transferred through the Benex’s accounts.[13] It has been equally proved that in Italy Russian criminals have used the accounts in order to “launder” their revenues from racketing Russian entrepreneurs having business in this country.[14] The total volume of all suspicious transfers from the BONY accounts to Italy was about $5,5bln. The purely criminal capitals represent about $200bln of $4,2 milliards transferred through the accounts in BONY.[15] The major part of transferred capitals has not criminal origin. Its transfer should be explained primarily by unfavourable institutional climate in Russia (this aspect will be analysed in more detail in the chapter 2). This climate creates incentives for tax evasion and freezing the investments into the national economy (the question of goals of the capital transfers will be studied in the chapter 3). Consequently, the major part of these funds should be considered as legal and extralegal.

As far as the channels of the capital transfers are concerned, all techniques used for transferring the funds on the BONY accounts are described in detail in the present report (see chapter 4). For example, there are suppositions that the BONY accounts were used for accumulation of resources coming from the operations with the American Deposit Receipts (ADR) issued for Russian securities[16] (see chapter 4.7). At the other hand, the pretended transactions (see chapter 4.2) were widely used by the owners of capitals transferred through the BONY accounts in order to minimise taxes.[17] It is worth emphasising that the addressees of transfers made through the BONY include such respectable corporations as Sony, Volkswagen, Daimler Chrysler, Hewlett-Packard, Nestle, Motorola. Finally, there is information about connections between the BONY accounts and off-shore companies and banks (see chapter 4.3).

Generally speaking, the proposed methodology would appear useful in analysing the cases like the BONY affair. In particular, constructing by international banks the sociological portraits of their potential clients (see chapters 7 and 8) would prevent the banks from opening accounts for criminal and extralegal entrepreneurs. Otherwise stated, the practice of filling in the special questionnaire (see chapter 9) by potential clients would allow the bank to get the information about their legal, extralegal or criminal nature. If Lucy Edwards, Peter Berlin and Alexis Volkov (the accused in the BONY affair) were asked to pass the test, the BONY would be much more vigilant in relationships with them. Although the methodology for defining the type of international financial market’s subjects is far from being finished (there is a need for additional field studies), the results look very promising (these results are given in the Supplement).

I.Fund transfer from Russia: goals, channels and methods of struggle.

  1. The definition of the problem.

There is a lot of definitions of the term «fund transfer»: economic, juridical, institutional. For example, the economists speak about the fund transfers in the terms of the search for highest rate of return. “Unrestricted transactions in international assets allow the world economy to invest in the assets with the highest rate of return, wherever they are located. If savers in Britain can earn a higher return by lending in Japan, why should they be forced to lend to low-yielding investment projects in the UK?”[18] From the juridical point of view it is defined as the transfer of assets from the territory of one state to the territory of another. The jurists speak about the fund transfers when the period the assets stay abroad is unlimited by the contract terms.

Speaking about assets we mean res corporales and foreign currency: there is no reason to transfer the assets denominated in unconvertible rubles. If we take into account only this meaning of fund transfer, it is not clear why fund transfer from London to New York is called transfer and from Santiago to Miami – capital flight.[19]

Furthermore from the statistical point of view, fund transfer is evaluated through the balance of payments. The volume of fund transfers made in accordance with the Law could be evaluated with the help of the accounts «Direct investments abroad». Otherwise stated, the volume of fund transfers made since 1993 in accordance with the Law is about 5,3 millions dollars. If we refer to fund transfers made in violation of the law, we should look at the accounts «Net errors and omissions», «Change of debt on defaulted payments from foreign currency and rouble export earnings and non repaid import advances», «Commercial credits and advances granted» and «Commercial credits and advances extended».[20] We should take into consideration that not all “net errors and omissions” represent the fund transfers, i.e. the real volume of fund transfers evaluated this way will be less than the sum of this account, 40 millions dollars. Meanwhile the analysis of the balance of payments can give us only a very rough idea of the reasons of fund transfers.

Balance of Payments of the Russian Federation for 1993-99 (neutral presentation) ($ mln.)[21]

Main Aggregates / 1993 / 1994 / 1995 / 1996 / 1997 / 1998 / 1999 (Q1)
CURRENT ACCOUNT / 12,792 / 8,870 / 7,778 / 12,011 / 4,049 / 2,446 / 5,068
Goods and services / 14,215 / 10,959 / 11,074 / 17,212 / 12,752 / 14,156 / 6,115
Export / 67,898 / 76,250 / 93,231 / 103,555 / 103,197 / 87,688 / 17,831
Import / -53,682 / -65,291 / -82,157 / -86,343 / -90,445 / -73,533 / -11,716
Goods / 15,590 / 17,675 / 20,476 / 22,933 / 17,440 / 17,306 / 6,473
Export / 59,724 / 67,826 / 82,663 / 90,563 / 89,038 / 74,751 / 15,608
Import / -44,133 / -50,152 / -62,188 / -67,629 / -71,599 / -57,445 / -9,135
Services / -1,375 / -6,716 / -9,402 / -5,722 / -4,688 / -3,150 / -358
Export / 8,174 / 8,424 / 10,567 / 12,992 / 14,158 / 12,937 / 2,223
Import / -9,549 / -15,140 / -19,969 / -18,714 / -18,846 / -16,087 / -2,581
Investment income and compensation of employees / -2,302 / -1,782 / -3,368 / -5,339 / -8,411 / -11,359 / -997
Receivable / 2,908 / 3,500 / 4,278 / 4,333 / 4,366 / 4,300 / 2,261
Payable / -5,210 / -5,282 / -7,646 / -9,672 / -12,777 / -15,659 / -3,258
Compensation of employees / 0 / -114 / -303 / -406 / -342 / -164 / 67
Received / 0 / 108 / 166 / 102 / 227 / 301 / 102
Paid / 0 / -222 / -469 / -507 / -568 / -465 / -35
Investment income / -2,302 / -1,668 / -3,065 / -4,933 / -8,069 / -11,195 / -1,064
Receivable / 2,908 / 3,392 / 4,112 / 4,232 / 4,140 / 3,999 / 2,159
Payable / -5,210 / -5,060 / -7,177 / -9,165 / -12,209 / -15,194 / -3,223
Current transfers / 879 / -307 / 72 / 138 / -291 / -351 / -50
Received / 1,346 / 237 / 810 / 765 / 349 / 223 / 55
Paid / -467 / -543 / -738 / -627 / -641 / -574 / -105
CAPITAL AND FINANCIAL ACCOUNT / -6,540 / -8,538 / 1 / -3,380 / 3,766 / 5,469 / -4,218
Capital account / -284 / 2,410 / -347 / -463 / -797 / -382 / -76
Capital transfers / -284 / 2,410 / -347 / -463 / -797 / -382 / -76
Received / 2,611 / 5,882 / 3,122 / 3,066 / 2,137 / 1,704 / 198
Paid / -2,895 / -3,472 / -3,469 / -3,529 / -2,934 / -2,086 / -274
Financial account / -6,257 / -10,948 / 348 / -2,917 / 4,562 / 5,851 / -4,142
Direct investment / 1,069 / 538 / 1,658 / 1,708 / 3,640 / 1,156 / 334
Abroad / -142 / -101 / -358 / -771 / -2,603 / -1,027 / -314
To Russia / 1,211 / 640 / 2,016 / 2,479 / 6,243 / 2,182 / 648
Portfolio investment / -374 / 36 / -2,408 / 8,757 / 45,433 / 7,779 / -528
Assets / -489 / 114 / -1,705 / -172 / -156 / -256 / -23
Liabilities / 115 / -78 / -703 / 8,929 / 45,589 / 8,035 / -506
Other investment / -4,131 / -11,574 / 10,408 / -14,739 / -42,556 / -8,339 / -5,020
Assets / -15,330 / -17,683 / 5,042 / -29,067 / -26,621 / -16,122 / -6,050
Cash foreign exchange / -3,619 / -5,740 / 134 / -8,669 / -13,444 / 945 / 201
Balances in current accounts and deposits / -3,838 / 162 / 4,327 / -1,000 / 977 / 972 / -1,098
Commercial credits and advances extended / -2,400 / -3,698 / 8,043 / -9,501 / -6,789 / -6,810 / -1,799
Loans and credits extended / 7,913 / 9,536 / 8,641 / 9,499 / 7,004 / 5,345 / 1,791
Arrears / -11,619 / -12,771 / -10,553 / -9,475 / -3,048 / -7,428 / -4,058
Change of debt on defaulted payments from foreign currency and rouble export earnings and non repaid import advances / 0 / -3,860 / -4,928 / -9,773 / -11,458 / -8,625 / -1,016
Other assets / -1,767 / -1,312 / -623 / -149 / 136 / -520 / -71
Liabilities / 11,199 / 6,110 / 5,366 / 14,328 / -15,935 / 7,784 / 1,030
National currency / 548 / -325 / 391 / -230 / -38 / 65 / -9
Balances in current accounts and deposits / 645 / 1,686 / 2,464 / 1,547 / -4,694 / -2,832 / -283
Commercial credits and advances extended / 0 / -978 / -8,050 / -799 / -64 / 321 / 104
Loans and credits received / 5,857 / 2,242 / 8,508 / 10,256 / 12,691 / 5,806 / -1,283
Arrears / 3,364 / 3,162 / 1,131 / 2,672 / -24,339 / 5,120 / 2,414
Other liabilities / 785 / 321 / 922 / 881 / 511 / -697 / 86
Reserve assets / -4,354 / 1,896 / -10,386 / 2,841 / -1,936 / 5,305 / 969
Adjustment to reserve assets[22] / 1,534 / -1,844 / 1,076 / -1,484 / -19 / -50 / 104
Net errors and omissions / -6,252 / -333 / -7,780 / -8,631 / -7,815 / -7,914 / -850
Overall balance / 0 / 0 / 0 / 0 / 0 / 0 / 0

Let us try to formulate an institutional definition of the fund transfer, because it is the institutional economics that, first of all, pays attention to the question of incentives to economic actions. Let us drive apart two terms – capital flight and fund transfer, legal, extralegal and criminal. While using the term “capital flight”, we speak about the investment that was transferred abroad in legal or extralegal way, revenues from which would not be returned to the country.

Capital flight can be explained by unfavourable climate for investment (including the tax regime), unstable environment and ineffective enforcement of property rights, which means for owners of assets much more than a high rate of profit. In other words, we can use the term of capital flight if the institutional environment of a country can not stimulate reinvestment into the national economy.

Speaking about capital flight, the stress is not on the methods of assets transfers but on the incentives to such transfers. On the contrary, using the term «fund transfers» we analyse legal, extralegal and criminal methods of transferring. In some cases, funds of criminal origin[23] could be transferred abroad following legal channels (see, for example, part 4.5 “Fund transfers in cash”). And so the fund transfer itself could be the mechanism of the legalisation of criminal capital. Till recently, there were legal opportunities to transfer funds of any origin. «You can buy certificate in bank, to be more correct – even not to buy – you remit a sum of money and then immediately draw it back and get the reference that you have withdrawn the sum – the certificate is the statutory ground for transfer. Where did you take the money? – Withdrew from the account».[24]

Consequently, the term «capital flight» is used to analyse the goals and incentives to transfer funds from the country with unfavourable institutional environment for business to the country with more effective institutional system. The term «fund transfer» is more of technical character and describes the methods of fund transfer. In our further analysis we will take into account both aspects: incentives to transfer funds and methods of transfer.

  1. The current situation in the Russian economy.


In order to evaluate the attractiveness of the Russian economy for the reinvestment we have to look at the statistical indicators describing the situation during the 90s. The GNP has been declining since 1991 (in % to the previous year).[25]