Financial Fraud Research Paper

Danske Bank: How money got laundered through

Denmark’s biggest bank

FIN 4303

Professor Krishnan Dandapani

July 28, 2020

P a g e | 1

What Happened

During the year of 2018 Danske Bank, a bank located in Denmark was involved in a controversy

regarding suspicious transactions and funds. The funds in question came from the Estonian branch. It was

believed that from 2007 to 2015 the Estonian branch was being used to clean “dirty money”. This money-

laundering scheme is believed to be one of the largest schemes in Europe. A total of around 200 billion

euros was believed to be linked to illegal activities such as organized crime and tax evasion.

Profit Distribution

The Estonian branch was used for suspicious incoming funds coming from many different countries

including Russia, Latvia, Cyprus, and the United Kingdom. The incoming funds consisted of 23% coming

from Estonia, 23% from Russia, 12% from Latvia, 9% from Cyprus, 4% from the UK, and the rest from

83 other countries.

According to Danske Bank, the funds in question were linked to a non-resident portfolio in the Estonian

branch. Throughout the periods, the non-resident portfolio generated around an average of 60% of the

before-tax profits that came from the Estonian branch. In some of the years, the majority of the reported

profits came from the Non-Resident portfolio. In the year 2013 for example, it was reported that 99% of

the profits came from the non-resident portfolio. During 2015(the last year the portfolio was open) the

Estonian branch generated around 352,000,000 DKK ($54 million). Throughout 2007 to 2015 the

Estonian branch generated around 5% of Danske Bank total before-tax profits. The chart below illustrates

the profits generated by the non-resident portfolio as reported by Danske.

Estonia Russia Latvia Cyprus UK Other

Funds 23% 23% 12% 9% 4% 29.00%

0%

5%

10%

15%

20%

25%

30%

35%

Funds

P a g e | 2

As we will later discuss, many of the inbound and outbound funds were claimed to be coming from

mirror trades. Throughout the years it was various customers that constituted the portfolio in question. It

was approximately 10,000 customers that were part of the non-resident portfolio. The non-resident

portfolio customers consisted of around 2% to 4% of the total number of customers within the branch.

Most of the profits generated by the branch came from the small percentage of customers in the non-

resident portfolio. Most of these incoming funds were deemed to be suspicious. Throughout the year’s

management within the Estonian branch actively ignored the red flags that were brought up. In 2014 a

whistleblower brought the suspicious activities to the attention of Danske’s executives. By late 2015

Danske terminated all operations of the non-resident portfolio due to many red flags and suspicions

regarding money laundering.

Assets and Balance Sheet Portion

According to Danske, the portion of total assets related to the Estonian branch was at around 0.5% of the

total assets. Below you can find the Asset portion in the balance sheet for the year 2015. Data provided

stated in DKK millions.

4 9

%

5 2

%

5 0

%

5 0

%

6 9

%

9 4

%

9 9

%

9 5

%

4 7

%

2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5

P E RC E N T O F P RO F I TS G E N E R AT E D BY N O N - R ES I D E N T P O R T FO L I O

Cash in hand 76,837

Trading portfolio 547019

Investment Securities 343,304

Loans at amortised cost 1,079,257

Loans at fair value 741,660

Assets under insurance contracts 265,572

Intagles 6,505

Other assets 232,724

TOTAL ASSETS 3,292,878

P a g e | 3

The total assets amounted to 3 trillion DKK or around 500 billion USD. Since the branch’s assets were

around 0.5% of total assets then we can assume that the Estonian portion of the assets is worth around 16

billion DKK or around 2.5 billion USD. We can assume that a large portion of the reported assets is

largely due to fraudulent behavior or more specifically money laundering making this asset portion

worthless.

How It Happened

The origin of the money within the non-resident portfolio was believed to have come from many shell

corporations. It is believed that these corporations where being run by the same owner and some links to

the Putin family. This however is still unclear due to the lack of public information currently available.

Although there is not much public information regarding the origin of the “dirty” money, there is,

however, sufficient information on how the funds were cleaned.

Mirror Trades

One of the ways the money was laundered was through mirror trades. Although mirror trades are legal,

many people think that they are often linked to suspicious or illegal activities. The process of how the

Estonian branch was cleaning the money is as follows:

• The clients within the non-resident portfolio bought Russian government bonds with the illegally

obtained money.

• The government bonds were then deposited in a Danske account from a branch located in Russia.

• The bonds were then sold through the Estonian branch converting rubles to USD or another

foreign currency.

• After the conversion from rubles to USD, the money was effectively cleaned from any illegal

activity.

Howard Wilkinson, an ex-employee of the Estonian branch, mentioned how daily up to 20 million rubles

were being converted to USD. Many of the customers he believed to be suspicious and not properly

vetted.

Danske, through brokerage fees, benefitted financially through the various transactions occurring within

the non-resident portfolio. They made their money through these trades by charging around 0.07 to 0.1

percent fee. The Financial Times estimated that in 2013 Danske generated around 6 to 8 billion euros in

revenue from brokerage fees.

P a g e | 4

Many other banks including J.P Morgan were involved with the Estonian branch. Due to the high level of

suspicious activities regarding the mirror trades, J.P Morgan terminated all business with Danske’s

Estonian Branch. Deutsche Bank, another bank involved with the branch, continued to do business with

the branch. They continued to make the wire transferred on behalf of the Estonian branch. In the later

years, management would receive heavy criticism regarding the ignoring of the suspicious foreign

customers.

Motives and Managerial Negligence

The motives behind any person looking to clean dirty money are simple. The criminal is simply trying to

free their money and themselves from any criminal activity. Therefore, validating the large “clean” bank

account they have. Trying to explain why a criminal is trying to get away with dubious and illegal

activities is simple. However, trying to understand why a major bank would allow obvious illegal

transactions to occur is not that simple.

To answer the latter question, one could simply answer it by just excusing the employees within the

branch and claiming this as a simple accident or just simply due to negligence. However, this appears not

to be the case. In 2018 Estonia arrested ten Estonian citizens who they believe helped the money

laundering process. The employees arrested seem to be responsible for vetting and making sure money

laundering does not occur. Instead of preventing any money laundering from happening, the employees

just made it easier. They are also under suspicion of taking bribes or helping to take bribes. The motive

behind the employees hired by Danske seems to be because of personal monetary reasons.

This however only explains a portion of the people responsible. Management, although unclear whether

they were directly involved, have some fault. Management is responsible for making sure the business

operates within the legal grounds. Therefore, they are responsible for any illegal actives that may have

occurred while the Estonian branch was in operation. After going through investigation, they found

lacking efforts in AML (Anti-Money Laundering), little compliance with the recommendations assessing

risk, and overly relying on local management. After the news broke out, the then CEO Thomas Borgen

ended up resigning. Since there still is not enough information on the involvement of executive

management, we can speculate about two potential motives management could have had. The

management could have been worried about losing partial revenue generated from the Estonian branch or

this could have occurred simply be due to management negligence. With the information, we have

available it is more likely to be the latter reason.

P a g e | 5

Financial Implications

From 2015 to 2018 there was very little news regarding the Danske bank money laundering problem. It

was not after many articles were written and news broke out that Danske felt the repercussions regarding

the negligence in how they handled this situation. This affected Danske both financially and indirectly by

losing customer and investor confidence.

Fines

Before any major news broke out however, Danske was already facing regulatory problems with

Denmark, the U.S., and some European countries. In 2017 Danske paid around 12.5 million DKK or 2

million USD in fines for violations regarding anti-money laundering rules. Due to the backlash they had

once news broke out in 2018, the Danish bank decided to donate the profit generated by the non-resident

portfolio. In 2020, as the case comes to a close, it is expected that Danske will be fined a total of 13.5

billion DKK by Denmark, the U.S, and the United Kingdom. Some analysts are estimating that due to the

hefty fines, in 2020, the total operating expenses will increase to around 40 to 50%. They expect the

operating cost to go up to 42.3 billion DKK and will not return to normalized levels until 2021 which has

averaged at around 27 billion DKK.

Below you can find the consolidated financial statements for the years 2018 and 2019. This data came

from Danske Bank 2019 annual report.

(DKK millions) 2019 2018

Interest income calculated using the effective interest method

Other interest income 69,819.00$ 59,767.00$

Interest expense 41,927.00$ 30,746.00$

Net interest income 27,892.00$ 29,022.00$

Fee income 16,437.00$ 17,312.00$

Fee expenses 6,079.00$ 6,932.00$

Net trading income or loss 34,533.00$ (10,237.00)$

Gain or loss on sale of disposal groups 1,879.00$ -

Income from holdings in associates 386.00$ 451.00$

Other income 4,857.00$ 4,777.00$

Net premiums 26,316.00$ 25,963.00$

Net insurance benefits 58,106.00$ 13,400.00$

Operating expenses 30,960.00$ 28,020.00$

Impairment charges on goodwill 1,603.00$ -

Profit before loan impairment charges 15,551.00$ 18,936.00$

Loan impairment charges 1,729.00$ (387.00)$

Profit before tax 13,822.00$ 19,322.00$

Tax (1,249.00)$ 4,460.00$

Net profit 15,072.00$ 14,862.00$

P a g e | 6

Although it is difficult to project financial data into the future, we can make some reasonable assumptions

on what the expenses will look like for the year 2020 using past financial data. Using the income

statements from 2015 to 2019 provided by Danske I have projected what the income statement could look

like including the extra operating cost due to the fines.

To arrive at these numbers, I have taken the average of the interest revenue, and all expenses not

including any extraordinary or one-time expenses. For the operating expense, I added the 42.3 billion

DKK previously mentioned. The projected net profit for the year 2020 was 3.6 Billion DKK which is 76

percent less than the 2019 net income. Danske’s profit margin in the year 2019 was around 22%. After

adding fines, the profit margin decreased from 22% to 5%.

These estimates, however, are only estimates assuming normal operations. We have to keep in mind that

estimates most of the time if not always are wrong. However, assuming that the profit margin in normal

operations with the added fines expense is as low as 5%, is a big deal. With a profit margin that low, the

bank is more vulnerable to any unexpected change. For example, revenue cannot fall below 5%. If this

were to happen, this alone will make them unprofitable for the year. Even if revenue were to not fall by a

lot, they are still vulnerable when it comes to unexpected or one-time expenses. This fact increases their

margin of error and forces them to operate more conservatively for the year 2020.

(DKK millions) 2020 Projection

Interest income 62,386.00$

Interest expense 31,211.67$

Net interest income 31,174.33$

Fee income 16,225.78$

Fee expenses 5,859.00$

Net trading income 12,297.75$

Other income 5,107.00$

Income from holdings in associates 586.00$

Net premiums 24,148.33$

Net insurance benefits 35,631.00$

Operating expenses 42,300.00$

Profit before loan impairment charges 5,749.20$

Loan impairment charges 541.50$

Profit before tax 5,207.70$

Tax 1,562.31$

Net profit for the year 3,645.39$

Percentagte change since 2019 -76%

P a g e | 7

Investor Confidence

After many articles regarding this case where written and the money laundering case became clearer,

investors, as expected, were not too happy about it. One way to show investors’ confidence in a company

is to look at the stock price since it reflects the supply and demand of the company’s total shares.

While the events were unfolding, investor confidence remained fairly high. This may be due to Danske

not mentioning or discussing any concerns regarding their non-resident portfolio. The stock had gone up

from 95 DKK in 2012 to around 250 DKK in 2018 (160% increase in price). At this point in time investor

confidence remained high. It was not until many articles where written and the money laundering events

went public that the stock dropped. From 2018 to 2019 the stock had dropped to around 90 DKK

(negative 64%) and remained falling throughout 2020 (Largely due to the COVID-19 pandemic).

As of July 25, 2020, the stock is valued at around 105 DKK.

Using a reverse DCF calculation we can figure out what investors’ future outlook for the company looks

like. Since the free cash flow for 2019 and 2020 were negative, we will assume that cashflows will go

back to normal levels in 2021. Based on past financial statements the average free cash flow generated by

Danske was around 50 billion DKK. With these assumptions in place, at a market cap valuation of 90.3

Billion, the investors expect the company to grow at a negative 15% to 20% growth rate (DCF calculation

was done using an 8% and 10% discount rate). It is clear that at this price, investors’ future outlook

appears to still be negative.

P a g e | 8

What could be done to prevent recurrence

As we previously discussed, this happened largely due to managerial negligence. We concluded that

management did not follow anti money laundering rules and regulations. Money laundering regulations

exist for to prevent criminals from laundering illegally obtained money. Danske failed to properly follow

these rules which led to one of the biggest money-laundering scandals. One simple yet effective solution

Danske could have done is simply following the AML rules and regulations. For example, back in 2014

when the whistleblower reported suspicious criminal activity to management, they should have taken the

concerns seriously. If a financial institution suspects a customer of engaging in money laundering, it must

be reported to the Financial Intelligence Unit.

Another conclusion was the overly reliance on local management. Financial institutions have a duty of not

only following AML rules, but they also must make sure their employees are aware of these rules. It is

unclear whether local management was involved in the money laundering scheme, however, perhaps if

local management was reminded of these rules and the repercussions if these rules where broken, maybe

they would have taken any signs of money laundering seriously. The solution to a problem like this is

simple. Just follow the rules and you will not get in trouble.

It is clear that Danske is now very aware of these solutions. They are looking to make investments in

order to reduce risk and are helping in the investigation of the Estonian branch. Management is aware that

these investments will reduce short-term future performance, however, these investments are necessary so

they can improve customer and investor confidence for the long-term.

P a g e | 9

Bibliography (2018). Retrieved from Financial Times: https://www.ft.com/content/519ad6ae-bcd8-11e8-94b2-

17176fbf93f5

(2018, December 21). Retrieved from Reuters: https://de.reuters.com/article/us-danske-bank-

moneylaundering/danske-bank-fined-over-money-laundering-says-expands-internal-probe-

idUSKBN1EF18P

(2019). Retrieved from Financial times: https://www.ft.com/content/c72172cc-6b13-11e9-80c7-

60ee53e6681d

(2020). Retrieved from Yahoo Finance: https://finance.yahoo.com/quote/DANSKE.CO/

Danske Bank. (2015). Annual Report 2015.

Danske Bank. (2017). Annual Report 2017.

Danske Bank. (2018). Report on the Non-Resident Portfolio.

Danske Bank. (2019). Annual Report 2019.

Grugan, T. M. (2018, November 30). Retrieved from Money Laundering News:

https://www.moneylaunderingnews.com/2018/11/danske-bank-money-laundering-scandal-

the-tip-of-the-icebergs/

Jensen, T. (2018, Novermber 19). Retrieved from Reuters: https://www.reuters.com/article/us-danske-

bank-moneylaundering-explainer/explainer-danske-banks-200-billion-euro-money-laundering-

scandal-idUSKCN1NO10D

McConnell, P. (2020). Danske Bank-A Smorgaasbord of Risk.

Rees, J. (2018, September 27). Retrieved from S&P Global:

https://www.spglobal.com/marketintelligence/en/news-

insights/trending/xxuhwtpxfzitnvdopwhnjq2#:~:text=Danske%20Bank%20A%2FS'%20own,an%2

0anti%2Dmoney%20laundering%20expert.&text=This%2C%20said%20Barrow%2C%20suggests

%20mirror%20trading%20was%20involved.