(Adds finance minister, context)
By Gederts Gelzis
RIGA, March 21 (Reuters) - Latvia will put forward legislation to ban shell companies, Prime Minister Maris Kucinskis said on Wednesday, after a chorus of demands from its Western allies that it clamp down on money laundering.
Latvia is struggling to restore confidence in its financial institutions after U.S. accusations that the euro zone state's third biggest bank, ABLV, was serving as a conduit for illicit funds. The bank, whose former management denies wrongdoing, was shut down last month.
"We have agreed today about the prohibition of shell companies in Latvia," Kucinskis told a news conference. If the legislation is passed in early April as the government plans, it could come into force in May, he said.
The use of shell companies has been widespread in Latvia, with the country's financial watchdog putting their number at over 26,000.
They can be used to obscure the real owner of assets and make it difficult for authorities to ascertain the origin of funds.
Latvia has more than 10 banks that deal primarily with non-resident deposits, many from customers in Russia and other ex-Soviet states who often use shell companies in their business dealings.
Finance Minister Dana Reizniece-Ozola said banks would be given only "a very short time" after the legislation came into effect to wind up deposits with shell company clients. Kucinskis suggested the grace period could be six months.
The financial watchdog will be involved in the process of severing those links.
Its head, Peters Putnins, said clients who failed to withdraw their funds during the transition period would have their money set aside and require regulatory approval to access it once the deadline had passed.
The United States, an important military ally for the former Soviet-ruled country, is watching closely to see how Latvia tackles the issue of money laundering.
The Baltic state's reputation has also been tarnished by the detention of the governor of its central bank, Ilmars Rimsevics, in a separate bribery investigation. He denies any wrongdoing.
The European Union has been encouraging member states to tighten anti money laundering legislation and ensure their banks are not taking in questionable funds.
Highlighting the scale of the challenge Latvia faces, the country launched just 85 money-laundering investigations in 2017 even though its banks flagged 17,900 suspect transactions, data seen by Reuters shows.
At the end of last year, non-resident deposits accounted for about 40 percent of total deposits in the Latvian banking system, though withdrawals since the measures against ABLV have seen that decline somewhat. (Reporting by Gederts Gelzis, additional reporting by Johan Ahlander in Stockholm and John O'Donnell in Frankfurt; writing by Niklas Pollard; editing by John Stonestreet)