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International Offshore Banking

by the Investors Offshore Editorial Team, October 2011
14 October, 2011


In an increasingly globalised world, in which more and more of the population are becoming internationally mobile, there is a growing need for financial services which reflect people’s circumstances, and consequently the market for offshore and international banking services is probably larger and more diverse now than it has ever been.

As a result, there is a huge spectrum of different banking services, based on-shore and off, available to expats, international investors, globetrotters, international consultants and corporations, offering varying degrees of return, protection, and privacy. Before we look into the whys and wherefores of  offshore banking in particular, a brief rundown of the background of this ever-growing industry is necessary, in order to understand the present situation.

The Post-Crisis Landscape

The debt crisis of 2008-2010 (well, maybe it is still going on) was blamed rightly or wrongly on ‘the banks’, and it’s true that in the eye of the storm many banks had to be rescued  from the consequences of unbridled credit expansion, and this at a time when their formal stability was being enhanced under Basle 2. But the damage, however great in monetary terms, was limited to the USA, the UK and certain parts of continental Europe. Many banks, and many parts of the world, escaped harm.

Credit default swaps and rating agencies can’t be uninvented, even if they can be better controlled, and it may be that one day this particular crisis may come to be seen as just the ‘growing pains’ of an adolescent globalized financial structure. Bankers may make mistakes, but they aren’t suicidal; they are as capable of learning as the rest of us.

Governments haven’t taken the long view, however, and have reached for the statute book in response to the crisis, with far-reaching regulatory reforms under way in the regions most affected.

The United States for example is in the process of implementing the Dodd Frank Wall Street Reform and Consumer Protection Act which is changing the regulatory foundations of the entire US financial system. While the aim of the legislation is to prevent a repeat of the events which led to the financial crisis of 2008/09, many fear it will leave the US banking industry over-regulated and at a competitive disadvantage with many other parts of the world.

The UK’s plans for a shake-up of its banking system are also expected to have a widespread impact on the way banks operate there in the future, although there is no consensus on whether this will be for the better as far as depositors and investors are concerned. The main proposal arising out of the Independent Banking Commission’s report in September 2011 is for the ring-fencing of a bank’s domestic retail services from its global wholesale/investment banking. A return to Glass-Steagall, say many, and likely to have the same consequences. If the government adopts the Commission’s proposals, and recent evidence suggests that it is generally supportive of the report, then they would go much further than anything that has been proposed elsewhere.

The EU is also active on the banking reform front, however. Only partly in response to the crisis, the EU has created a new architecture for supervision at European level with three new European Supervisory Authorities replacing the former European Committees for the banking, securities and insurance and occupational pensions sectors - the European Banking Authority, the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority. In July 2011, Michel Barnier, the European Commissioner responsible for the Internal Market and Services, introduced a proposed joint directive and regulation which, after a long consultation and preparatory process, is aimed at strengthening the resilience of the European banking sector. By putting together all the legislation applicable to bank governance, the EC proposes to have a ‘single rule book’ for banking regulation, to improve both transparency and enforcement.

In addition to this developing carapace of regulation, a number of European countries have taken the opportunity to ‘punish’ the banks with special levies, which will be ongoing in some cases. And talk of a ‘Tobin’ tax on financial transactions has reached fever pitch in the Eurozone.

All these self-imposed handicaps can only have one result, you might think, which will be a gradual, or maybe not so gradual leaching of financial activity away from ‘Western’ markets to more welcoming markets in other parts of the world, notably the Asia-Pacific region.

Privacy and Transparency

Although some awareness of strategic developments in banking is valuable background, most users of international banking services are probably more concerned with the growing threat to banking privacy as a result of the on-going campaign by the OECD and the G20 to impose higher standards of transparency on offshore banking centres, in response to 9/11 and what the richer countries see as ‘unfair’ tax competition.

Following the G20 meeting in London in March, 2009, when the OECD published its new 3-tier blacklist, jurisdictions increasingly have entered into international agreements that permit breaches of confidentiality in some circumstances, often under the auspices of a Tax Information Exchange Agreement (TIEA). TIEAs have become prevalent since the OECD succeeded in imposing standardized rules for mutual information exchange on almost all countries and territories in 2008. Typically, a TIEA (or equivalent wording in a Double Tax Treaty) will permit one country to extract information from another when it has prima facie evidence of wrongdoing (including tax evasion) on the part of a named person or company.

US citizens face particular difficulties. Following the years of 'benign neglect' of the offshore issue under George W. Bush, the game suddenly, but not unexpectedly, changed under President Obama, who assumed the office of President in January 2009. Under proposals announced by the US Treasury in May, a foreign financial institution (FFI) that has dealings with the United States will be required to sign an agreement with the US Internal Revenue Service to become a Qualified Intermediary and share the same information about its US customers as is currently required of US financial institutions, “or else face the presumption that they may be facilitating tax evasion and have taxes withheld on payments to their customers.”

In March, 2010, as part of the Hiring Incentives to Restore Employment (HIRE) Act, the Obama Administration included the Foreign Account Tax Compliance (FATCA) Act. The FACTA provisions of the HIRE Act add a new chapter 4 to Subtitle A of the Internal Revenue Code. Chapter 4 expands the information reporting requirements imposed on FFIs, with respect to accounts held abroad by US residents.

FFIs are required to deduct and withhold a tax equal to 30% of the amount of any payment received on behalf of a US person unless the FFI agrees to disclose the identity of the US residents and report on their bank transactions.

The name, address and taxpayer identification number (TIN) is required of each account holder which is a specified US person; and, in the case of any account holder which is a US-owned foreign entity, the name, address, and TIN of each substantial US owner of such entity. The account number is also required to be provided, together with the account balance or value, and the gross receipts and gross withdrawals or payments from the account.

Financial institutions worldwide, and their governments, are protesting to the US about these rules, which are indeed very onerous. If they are not changed, and there is no sign of this while Obama and his congressional colleagues continue with their anti-rich pogrom, then the consequence may well be that international financial institutions will refuse US clients, who will be driven to all manner of subterfuges to maintain their privacy. It should be good for the market in Eastern European and Asian spouses, at any rate.

Europe has also been doing its bit to make life difficult for its own citizens with the Savings Tax Directive, which has meant that for the last six years all EU member states and a number of their offshore dependent territories are either placing a withholding tax on the returns on savings paid to citizens of EU member states, or are passing information about the payment to the citizens' home countries. The EU put pressure on Switzerland, where tax avoidance is not a criminal activity (and which is not actually an EU member), to agree to exchange of information on the identities of depositors and savers, but the Swiss, who have always been fiercely protective of their banking secrecy laws, put forward a compromise whereby their existing withholding tax system would be extended and strengthened, which was reluctantly accepted by the EU.

In fact it is easy to escape the operation of the Savings Tax Directive, with statistics showing far lower levels of reported or taxed interest had been expected. Needless to say, the European Commission wants to extend the directive by including certain other financial instruments and arrangements not previously covered, and to strengthen agreements with ‘third countries’ like Switzerland, but it has been sent packing by Singapore and Hong Kong, and seems unlikely to be able to gain approval for any extension of the Directive in Europe itself.

In summary, although many offshore jurisdictions have responded to this pressure from the OECD, US and EU by beefing up their legislation against money-laundering, and by introducing better controls over financial institutions, there has been little action towards any comprehensive watering-down of banking secrecy. In other words, foreign countries will continue to have to show cause before gaining access to confidential records in offshore jurisdictions, and no large-scale 'fishing expeditions' are likely to be to be permitted. In the longer-term however, the survival of banking secrecy seems doubtful.

Why should I open an offshore bank account?

Depending on your reason to be abroad, an offshore bank account could prove invaluable. Relocation, whether on a regular or one-off basis can have serious taxation implications for your assets, but if they are safely anchored in an offshore jurisdiction, barring unforeseen events they can remain there for the duration of your expatriation (and beyond), usually attracting favourable taxation and higher returns. However, it is probably advisable to open an account in your country of secondment for day to day transactions as well.
If you are employed in a profession which has a greater than average chance of attracting litigation (for example the medical profession), or are concerned about future attacks on your assets from family members, offshore bank accounts can also prove effective as asset protection vehicles.

What services are on offer from offshore banks?

This depends upon the organisation you choose to bank with, and the jurisdiction in which it is located. Nearly all international and offshore banks offer checking, savings and current accounts, many offer credit and debit cards, and some offer foreign currency services and investment accounts. Larger organisations, usually in the more regulated jurisdictions, also sometimes provide mortgages and other financial products. Other institutions offer IBC registration and maintenance. Increasingly, banks and financial service providers are recognising the need for online facilities (especially if they are hoping to attract an expatriate audience), and many now offer 24 hour online account access, and allow you to conduct much of your banking by e-mail or telephone.

However, bear in mind that in a lot of cases, these services (with the exception of online banking) are not offered for free, and the charges can vary significantly between jurisdictions and institutions. Therefore it is probably best to decide what you need from your offshore bank account before you start looking, and if you decide that you do need extra facilities, use them wisely, otherwise the charges can start to mount up.

Due Diligence

By now, most ‘offshore’ jurisdictions have open and effective regulatory regimes, and some of them even have deposit insurance schemes (for instance, the UK’s Channel Islands). But every now and again an uninsured ‘offshore’ bank goes belly up, and then you are on your own. Needless to say, it tends to be the banks offering the best rates that are most prone to failure. It is essential, therefore, that you are diligent in checking out possible homes for your money, and that if you do take risks, you take them with your eyes wide open.

There is a lot to be said for enlisting the services of a finance professional, but many self-advertised ‘experts’ know little more than you do yourself. Certainly, an adviser in the same location as the target institutions is compromised before you begin. And how can someone in another location know anything about the banking sector on an island halfway across the world? So you need to check your adviser just as thoroughly as they are supposed to be checking the bank you want to use.

Adviser or no adviser, it is worth doing a little research for yourself, and there are several things that you can do:

  • First of all, look at the established institutions in your jurisdiction of choice. In this way, you can gauge the standards of the industry there, and in so doing, give yourself a frame of reference.
  • Although longevity is an important plus point for an offshore bank in due diligence terms, it is not the only factor to be considered. Keep an eye out for any negative publicity in the media (this is where the internet comes in especially handy!)
  • Don't do business with a 'brass plate' bank. Although there has been a drive towards eradicating this type of institution, you need to make sure that the bank that you intend to entrust your hard earned cash to is the real deal (i.e. has an office, staff, a license, money, etc. Little things like that!) If you have come across the institution via its website, make sure that it is possible to make contact by other means than e-mail. Although the presence of a physical mailing address, and telephone and fax details do not in themselves indicate that a bank is legitimate, their absence may be a red flag.
  • Be wary of banks or providers offering interest rates that seem unusually high. Although there is certainly scope for good returns in the offshore arena, things that seem too good to be true usually are. When dealing with your future happiness and financial well being, it is a good idea to leave your faith in human nature at home!

Opening an offshore bank account

Due diligence is not just a one way process, and the amount that banks are required to conduct on potential customers increased greatly with the advent of 'Know your Customer' legislation in the last few years. If you are applying to open a bank account through an intermediary, or with an institution that has agreed to implement KYC, you will need to provide at least the following:

  • A notarised copy of your passport. If you don't have a passport, then a notarised copy of your birth certificate or driving license should be acceptable.
  • A recent utility bill (or equivalent document) with details of your permanent address.
  • A bank reference letter drawn on your domestic banks letterhead (or on the form sometimes provided by the offshore bank), and signed by the bank manager, stating that you are a reliable and suitable customer. The recommendation is that the reference letter is completed by a bank with which you have had a two year banking relationship, but six months is really the bare minimum.
  • A professional letter of reference from a doctor, lawyer, and accountant in your country of residence.
  • A letter of intent on source of funds. This is where you must lay out the projected account activity, and also the expected source of any funds deposited. KYC legislation means that if there is any suspicious or unusual account activity (i.e. if the actual amounts deposited or frequency of deposits differ from your projections), the banks must investigate this, and if necessary pass the information on to the relevant authorities.
  • The required minimum deposit. This will vary from institution to institution.

The jurisdictions

There are several key criteria which any offshore jurisdiction should fulfil before you consider banking there. These include (although are not limited to):

  • Political and economic stability
  • Strong infrastructure. A modern and reliable business infrastructure is usually a fairly good indicator of the stability of a jurisdiction, and is essential for a number of reasons.
  • Convenient location. Although expatriation, by definition, may mean that this differs as you move from country to country, it is still important to consider the geographical location of the country in which you intend to bank.
  • Investor/customer protection. As previously mentioned, some jurisdictions are more stringently regulated than others, and as such the chances of there being some kind of investor protection measures in place vary. However, in countries where the legislation is geared towards minimising risk, there may be other restrictions in place which limit the returns that it is possible to achieve.

There follows a brief description of the banking industries in some of the most popular offshore financial centres (but there are many other possible locations, described in moderate depth in http://www.lowtax.net):

Bahamas

The Bahamas is one of the world's top ten international banking centers, with 250 licensed banks from more than 30 countries, and a total asset base nearing USD1 trillion. Capital ratios average over 10%. The country's improved legislation and regulatory structure, its highly-skilled workforce, and its stable government have attracted some of the most prestigious financial institutions from around the globe. About half of licensed banks are incorporated locally, and more than half offer trust services alongside banking activity.

Private banking is a major component of the Bahamian banking industry: asset protection rather than tax avoidance as such is the driving force, so that the stability of the Bahamas alongside stringent banking secrecy and its sophisticated investment environment are very attractive to wealthy individuals, particularly those from the US where the Bahamas have a very good reputation.

New legislation enacted in 2000 in response to pressure from the OECD increased the degree of Central Bank supervision over the banking and trust sector.

Guernsey

There are 50 banks in Guernsey all of them are subsidiaries or branches of foreign banks. After rapid expansion in the '80s, the number of institutions remained roughly stable during the 1990s, but the deposit base continued to grow, reaching a high of GBP160bn in 2008.

Total deposits held with Guernsey banks at the end of June 2011 increased in sterling terms by GBP1bn from the end of March 2011 to reach GBP112.9bn. This represents a 0.9% increase over the quarter though it is still 2.5% lower than the same time a year ago.  Total assets and liabilities increased by GBP1.8bn to GBP139.2bn representing a 1.3% increase over the quarter, and 2.1% higher than the level a year ago. Swiss fiduciary deposits increased by GBP2.1bn to GBP40.4bn in June and these now represent 35.5% of all deposits with seven banks in Guernsey currently active in this area of business.

Jersey

At the end of December 2010, there were 45 banks in Jersey, holding deposits of just under GBP161.6bn.

In addition to commercial banking, asset management, foreign exchange and securities trading, Jersey banks are involved in a number of large securitisation programmes. The creation of the Channel Islands Stock Exchange encouraged the development of a larger capital issuance sector.

Whilst bank deposits held in Jersey showed a slight decrease over the quarter to the end of June 2011, deposits originating from the Far East and Middle East remained impressive, standing at GBP8.7bn and GBP20.4bn respectively. This continues to represent a combined total of around 18% of Jersey’s level of deposits and reflect the value of recent promotional activity in Hong Kong, Greater China and the United Arab Emirates.

Hong Kong

Hong Kong has one of the largest representations of international banks in the world: more than 70% of the world's 100 largest banks have a presence there. Hong Kong is the world's 9th largest international banking centre in terms of the volume of external transactions, and the second largest in Asia after Japan. The banking sector plays a vital role in establishing Hong Kong as a major loan syndication centre in the region.

In the first quarter of 2011, the aggregate pre-tax operating profit of retail banks’ Hong Kong offices rose by 26.6% from the same period last year. According to the HKMA, the strength in profitability was supported by increases in non-interest income and generally strong asset quality.

At the end of May 2011, there were 149 licensed banks (126 of which were incorporated outside Hong Kong), 20 restricted licence banks (of which eight were incorporated outside Hong Kong) and 26 deposit-taking companies in business (all incorporated in Hong Kong). These 195 authorised institutions operate a comprehensive network of 1,300 local branches. In addition, there were 66 local representative offices of overseas banks in Hong Kong.

Total employment in the sector is around 80,000. Banking assets amount to more than HKD10 trillion (US$1.2 trillion).

Luxembourg

A substantial international banking sector has developed in Luxembourg due to a combination of factors, including a relatively relaxed regulatory regime, the 'holding' company legislation (although this was phased out over the next three years from 2007, to be replaced - subject to EC approval - with the Family Private Assets Management Company, or SPF), the growth of the Euromarkets, and the existence of the Luxembourg Stock Exchange on which most Eurobonds are listed. It is also significant that CEDEL is based in Luxembourg.
As at November 30th, 2010, there were 148 banks registered in Luxembourg, according to the Commission de Surveillance du Secteur Financier (CSSF), which regulates the financial services sector. Assets are thought to be in the region of EUR930 billion.

Private banking services are particularly strong in Luxembourg, due to the absence of withholding tax on interest payments (other than under the EU's Savings Tax Directive), and tight banking secrecy, alongside the very wide range of financial products that is available. 
Banking secrecy has a statutory basis in Luxembourg.

Panama

The Panamanian banking industry grew during the last quarter of the 20th century into a regional banking centre for Latin American and the Caribbean, due to a variety of factors including the absence of exchange controls, the rapidly increasing volume of trade being conducted through the country (and through the Colon Free Zone in particular), liberal banking legislation and tight secrecy provisions. At the end of 1997 more than 100 banks were licensed in Panama, from more than 20 countries and with assets of about USD23bn; however the country responded to international pressure by tightening up on banking regulation, and a number of banks closed their offices in 2000 and 2001.

By 2007, the banking sector had rationalised further as foreign giants sought a piece of Panama's fast-growing services economy. Four deals at the latter end of 2006 had a major impact on the competitive environment of Panama's banking industry; these included HSBC's acquisition of Banco del Istmo - Panama's largest bank - for USD1.8 billion, and Citibank’s purchase of Grupo Financiera Uno, Latin America’s largest credit card issuer, for USD1.1 billion. By the end of 2007 total consolidated assets in the banking sector had reached USD69bn. The majority of assets are domestic, as opposed to offshore, reflecting continued strong demand for local real estate.

At the end of November 2010, there were 93 banks in Panama, with total assets of USD70.8bn.

Switzerland

Switzerland is the world's largest private banking center. It is home to over 500 major banking institutions and is estimated to hold up to 35% of the world's private wealth. In recent years a combination of legislative measures and market forces have re-orientated the Swiss banking services market so that banks cater less and less to the traditional small-to-medium-sized private accounts and more and more to large professional clients for whom sophisticated services are being offered at competitive prices. Assets under management of Swiss banks are estimated to top SWF10 trillion.

The Swiss banking industry is famous for its banking secrecy and despite immense external pressure and an apparent sway in public opinion, the government and Swiss bankers have maintained their commitment to banking secrecy in the face of the EU's efforts to apply its Savings Tax Directive across the whole of Europe. The Swiss government has pressed home the country's stance on several occasions, saying that Swiss secrecy laws are "not negotiable" and that they do not hinder free trade.

Two landmark agreements agreed with Germany and the UK in the summer of 2011, but subject to parliamentary approval in Germany and Switzerland, will give these two governments the ability to tax income from previously-undisclosed Swiss bank accounts held by their citizens, but will not loosen banking secrecy in any meaningful way.



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