One Holy Mess: Pope Francis Fights Institutional Corruption at the Vatican Bank

by Gregg Fields

They are scenes reminiscent of a Dan Brown novel: whispers of money laundering and connections to the mafia; a banker found hanging from the Blackfriars Bridge in London; and a powerful American consulting firm delving into the secrecy-shrouded financial arm of the Vatican.

But the drama surrounding the Institute for Religious Works, commonly known as the Vatican Bank, is not a sequel to the controversial bestseller The Da Vinci Code. The Vatican’s banking unit is in the middle of a firestorm of controversies and acknowledged lapses in oversight. The cleanup started under Pope Benedict XVI but has been thrown into high gear by Pope Francis. There are signs already that greater transparency and increased regulatory oversight are in the pipeline.

In a broader context, the saga of the Vatican’s bank is a telling example of how, given the right conditions, institutional corruption can infest organizations blessed by moral authority and endowed with a mission of public service. It shows how institutional corruption can insidiously erode the public’s trust in respected organizations, reducing the effectiveness of their leadership. It classically illustrates the moral hazards that arise when relations between the regulator and the regulated grow too cozy—in this case, they were virtually the same entity.

“To the consternation of the public and to the continued embarrassment of Catholics worldwide, the Vatican bank remains a rich source of material for Italian journalists, conspiracy theorists and anyone else who wants to build a case for Vatican intrigue,” wrote Francis J. Butler, former president of the Foundations and Donors Interested in Catholic Activities, in a recent commentary for the independent U.S. newspaper National Catholic Reporter. “The question before Pope Francis is whether the elimination of the Vatican bank entirely—which would mean giving up about $86 million euro in yearly profits—would be the only sure way to be free of further financial scandal.”

An Eternal Issue

The Vatican, of course, is one of the highest profile organizations in the world. In that sense, the pontiff’s banking reform efforts will naturally be widely watched around the globe, particularly the 1.2 billion Roman Catholics. Its bank, which most commonly goes by IOR, the Italian acronym for Istituto per le Opere di Religione (in English, the Institute for Religious Works) has been a lightning rod for controversy almost since its founding by Pope Pius XII in 1942, in the depths of the horrors of World War II.

If Pope Francis succeeds in saving the IOR and restoring its credibility, the results may prove to be a persuasive template for those addressing institutional corruption in other powerful entities such as Congress or Wall Street. Yet, as with financial reform following the financial crisis, the effort to rehabilitate the IOR is now several years old, illustrating the intractable nature of institutional corruption.

“Since 2010 the IOR and its management have been working hard to bring structures and processes in line with international standards for anti-money laundering,” Ernst von Freyberg, the IOR’s president, said this summer in announcing a management restructuring that saw the IOR’s director and deputy director resign. Von Freyberg, a German industrialist, was hired to clean up the bank earlier this year. “While we are grateful for what has been achieved, it is clear today that we need new leadership to increase the pace of this transformation process,” he said.

Scandals linked to the IOR are hardly new. It has been accused, though never found liable, for colluding with Croatia’s collaborationist government to steal assets from Hitler’s victims during World War II. A suit filed in the U.S. by Holocaust survivors, Alperin v. Vatican Bank, was ultimately dismissed on grounds that IOR is protected by the Foreign Sovereign Immunity Act. (Collaboration controversies have also long dogged the Bank for International Settlements, based in Basel, most recently in the book Tower of Basel by Adam LeBor.)

In the 1960s, controversy flared when the IOR hired Italian financier Michele Sindona as a financial advisor. The problem: Sindona was a central player in a seemingly endless number of banking collapses and financial swindles in Italy. His major American holding, Franklin National Bank, collapsed in 1974—reportedly costing the Vatican tens of millions of dollars—and he eventually was given a 25-year sentence for fraud related to the debacle. He was later extradited to Italy to face other charges, and died in prison in 1986 of cyanide poisoning. Whether it was suicide or murder was never determined.

Perhaps the most notorious blemish on IOR’s past, however, is the 1982 collapse of Italy’s largest bank, Banco Ambrosiano, with which the Vatican, as a shareholder, had a strong working relationship. Banco Ambrosiano’s chairman, Roberto Calvi, whose Vatican ties had earned him the nickname “God’s banker” despite a conviction for illegal foreign exchange transactions, was later found hanging from London’s Blackfriars Bridge. An initial finding of suicide was later discredited and it is now generally accepted that he was murdered. (A highly fictionalized character based on Calvi was a subplot in Godfather III.)

“Our biggest issue is our reputation,” von Freyberg conceded in an interview with Vatican radio earlier this year.

Self-regulating

How could a city-state with a population of 800 become so enmeshed in international financial intrigue? In essence, the IOR operated much like an “offshore” banking haven like Grand Cayman or Bermuda. Like those small islands, the Vatican City-based IOR had sovereign status. Its regulator is the Financial Information Authority, an internal watchdog of the Vatican. In recent weeks, the Vatican has essentially conceded that this led to what students of institutional corruption might call regulatory capture. In early August, the pope issued a Motu Proprio—a decree at his own initiative—that increased the FIA’s powers of supervision over the IOR.

Those who study institutional corruption often conclude that a lack of transparency is a contributing factor. It’s a relevant point in this case, because the IOR was perhaps the least transparent financial institution in the world. No branches, no shareholders and essentially no central banking authorities to whom it must answer.

It also has a structure that significantly limits the constituencies to whom it must answer. It doesn’t make loans, for instance, or perform other traditional bank functions. Only people like Vatican employees, clerics, and entities like charities and dioceses affiliated with the Holy See (the authority and government functions of the papacy) are allowed to have accounts. In one example of how inscrutable its operations were, the bank only developed a website in summer 2013.

Certainly, religious organizations are often granted a great deal of leeway in terms of privacy regarding their operations. However not many institutions own their own bank—one that, according to its new website, www.ior.va, has more than $9.4 billion in assets.

Outside Influences

Despite the publicly announced cleanup efforts, scandals have continued. One example concerns the case of Monsignor Nunzio Scarano. He was arrested earlier this year over an alleged plot to bring 20 million euros in cash into Italy. According to press reports, he is also being investigated for money laundering in southern Italy. The Vatican’s criminal court has frozen Scarano’s accounts.

It is worth noting, meanwhile, that the Vatican financial reforms, which gained traction under Pope Benedict XVI and are clearly gaining momentum now, came only after years of bruising international pressures. In 1989, the G-7 countries including the United States, Italy and the United Kingdom banded together to form the Financial Action Task Force, to coordinate international money laundering efforts. One of the biggest concerns then, at least for the U.S., was drug smuggling proceeds.

In the 1990s, Moneyval, an organization comprising smaller states belonging to the Council of Europe, was formed to combat money laundering. Global anti-money laundering initiatives gained new urgency after the terrorist attacks in 2001, with a number of international agreements forcefully lifting the shrouds of secrecy that had been one of the leading competitive advantages that banking havens historically enjoyed.

The Vatican only joined Moneyval in 2011, which led to a Vatican-requested review of IOR released last year. The report found the Vatican had “come a long way in a very short time” but that “further important issues still need addressing in order to demonstrate that a fully effective regime has been instituted.”

Besides bringing in von Freyberg, Promontory Financial Group, the prominent Washington consulting firm, has been hired to conduct a forensic review of the bank’s finances. In May, it signed an information sharing agreement with the U.S. Financial Crimes Enforcement Network (FinCEN).

“The IOR is engaged in a process of comprehensive reform, to foster the most rigorous professional and compliance standards. These efforts are based on the legal framework set forth by the Vatican, in cooperation with international bodies,” von Freyberg, the president, says in a letter posted on the IOR website. “This includes implementing strict anti-money laundering processes and improving our internal structures. We are conducting an extensive evaluation of all our clients’ accounts, with the aim of closing down those relationships that do not conform to our strict standards.”

Restoring Faith

In that regard, von Freyberg has hit upon what many observers have missed about the scandals surrounding the IOR. True, there appear to have been a number of unsavory characters with whom it associated. But what likely attracted them was a system that was easily subject to influence. A mutually dependent relationship—one might call it dependence corruption—seems to have developed between IOR and people that ultimately sullied the reputation of the institution. Long term, that undermined its moral authority.

As Lawrence Lessig, director of the Edmond J. Safra Center for Ethics, wrote recently: “Institutional corruption is manifest when there is a systemic and strategic influence which is legal, or even currently ethical, that undermines the institution’s effectiveness by diverting it from its purpose or weakening its ability to achieve its purpose, including, to the extent relevant to its purpose, weakening either the public’s trust in that institution or the institution’s inherent trustworthiness.”

That would suggest the IOR faces two challenges. One, it must create new systems that eliminate its vulnerability to the influences that lead to institutional corruption. Secondly, and perhaps more importantly, it must re-strengthen the credibility that lies at the heart of the public’s trust.

The question in this case is whether it’s too late. Pope Francis raised that possibility himself in a press conference earlier this summer. “Some say perhaps it would be better as a bank, others say it should be an aid fund, others say it should be shut down,” he said, during the return flight from his papal visit to Brazil. “But the hallmarks of the IOR—whether it be a bank, an aid fund, or whatever else—have to be transparency and honesty, they have to be.”