Andorra on the brink of Europe's next banking crisis

Andorra, the tiny Catalan principality nestling in the foothills of the Pyrenees between France and Spain, tends to conjure up images of scenic ski resorts, medieval churches and duty-free shopping.

The country has for many years enjoyed the benefits of European borders without the restrictions of EU membership, allowing light-touch regulation that has brought in tourism and wealthy expats from its bordering countries.

However, in the last three weeks, the state has been gripped by a banking crisis that threatens to take it to the brink. Bankers have been thrown in jail, savers’ deposits have been restricted, and the country’s government is scrambling to convince powerful regulators thousands of miles away that the country is not a haven for tax evasion.

On Tuesday March 10, the US Treasury Department’s financial crime body, FinCEN, accused Banca Privada d’Andorra (BPA), the country’s fourth-largest bank, of money-laundering. The authority said “corrupt high–level managers and weak anti–money-laundering controls have made BPA an easy vehicle for third–party money-launderers”.

Three senior managers at the bank accepted bribes to help criminals in Russia, Venezuela and China, to funnel money through the Andorran system, according to FinCEN.

The next day, the state took charge of BPA, dismissing three directors. On the Friday, the bank’s chief executive, Joan Pau Miquel, was arrested and detained. Mr Miquel remains in a jail cell in La Comella, the country’s only prison, with a capacity of 145.

At BPA, the Andorran authorities have installed new management. After international banks cut off links, withdrawals were capped at €2,500 (£1,830) a week, a limit many people are maxing out.

Banco Madrid, the Spanish subsidiary of BPA acquired as part of an expansion spree in recent years, filed for administration on Wednesday.

The Andorran government insists that BPA is an isolated case, saying it is committed to transparency and that the rest of the sector is clean. For its sake, it had better be right, but many experts fear this is not the case.

The state’s banks have assets under management 17 times bigger than the economy, and the sector accounts for a fifth of GDP – almost all of the rest is from tourism.

^{Banking is Andorra's second biggest industry after tourism (Alamy)}

Were its banks to get into trouble, Andorra, which is not a member of the eurozone but uses the single currency on an informal basis, would have no way of bailing them out.

In short, the country faces a catastrophe if its banks fall apart. The crisis is a classic example of how countries seeking to welcome financial services by promising a hands-off approach to regulation, can become dangerously vulnerable to them.

Andorra’s exposures to its banks provoke echoes of Iceland and Cyprus – both of which suffered painful economic crises when their lenders fell into trouble. But unlike Cyprus, which received a last-minute bail-out, Andorra has no central bank to act as a lender of last resort: if its banks go under, it goes under.

The crisis has now led Standard & Poor’s, one of the three major ratings agencies, to downgrade the value of the principality’s sovereign debt.

“The risk profile of Andorra’s financial sector, which is large relative to the size of the domestic economy, has increased beyond our expectations,” S&P said two weeks ago.

“The absence of a central bank or a lender of last resort in the Andorran financial system exacerbates the risks, in our opinion.” S&P said that the government, which runs on a budget of around €400m a year, would have almost no chance of supporting BPA, with assets of more than €3bn.

BPA may be put up for sale or into administration if it cannot recover. The real fear now is that the rest of the country’s banks have similar problems. Fitch put three Andorran banks – Credit Andorra, Andbank and MoraBanc – on negative watch last week, indicating it was likely to downgrade their debt.

“While the FinCEN allegations are specific to BPA, the escalation of events has underlined more uncertainty around access to funding and liquidity than was previously factored into the Andorran banks’ ratings, in particular in view of their relatively high dependence on non-residential customer deposits and the absence of a lender of last resort,” the ratings agency said,

“Despite a swift and strong response to BPA’s crisis by all parties involved, the reputation of the system and therefore the banks’ franchises may be damaged.”

A single bank is one thing, but contagion would be an altogether different beast. A collapse of the entire banking system would spell disaster, especially after the hubristic expansion of recent years.

Andorran banking assets have almost doubled since the financial crisis. Low taxes, combined with the minimal regulation that its lenders enjoy from being outside the European Union, have made it a haven for many investors.

It was not until recently that the country really began to scrutinise its banks, signing up to international conventions on reporting standards, exchanging tax information with neighbouring countries, and introducing stronger rules on bank capital.

Its finance minister, Jordi Cinca, told local television: “Andorra has initiated a transformation process and is committed with transparency, international standards of exchange of information and the fight against money-laundering.”

However, as the country’s ministers now race to avoid a crisis, Andorra may now find it is a case of too little, too late.