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OFFSHORE BANKING – REGULATORY ASPECTS
S. SRIDHAR
Executive Director
Export-Import Bank of India
This paper is organised into four parts, First a brief overview of the role of
offshore banking and the rise of offshore financial centres (OFCs).
Second, recent trends in regulation of offshore banking. Third, the status
of offshore banking in India as we make a cautious beginning. Fourth, the
way forward in the Indian context. The treatment is non-exhaustive,
coming as it does from a market participant and not a regulator.
I
Offshore Banking and rise of Offshore Financial Centres
In today’s highly integrated global network, international offshore
financial centres (OFCs) have come to play a vital role in facilitating
investment worldwide. An offshore centre exists by usage. It is recognised
by an amalgam of features which, taken together, offer particular
advantages for investment by non-residents. OFCs are jurisdictions where
offshore banks are exempt from a wide range of regulations, which are
normally imposed on onshore institutions. Specifically, deposits are not
subject to reserve requirements, bank transactions are mostly tax exempt
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from regulatory scrutiny with respect to liquidity or capital adequacy.
Information disclosure is also low. A summary description of regulatory
and tax regimes applied to offshore banks in select OFCs is presented in
Table 1.
Types of Offshore Financial Centres
Offshore Financial Centres can be classified into three main groups
depending on the offshore banks’ sources and uses of funds, the liquidity
of markets, and type of transactions.
Primary OFCs – Primary OFCs are large international full service centres
with advanced settlement and payment systems, operating in liquid
regional markets where both the sources and uses of funds are available.
London, the US International Banking Facilities (IBFs) and the Japanese
Offshore Market (JOM) belong to these category.
Secondary OFCs – Secondary OFCs differ from Primary OFCs in that
they intermediate funds in and out of their region, according to whether
the region has a deficit or surplus of funds. Such OFCs include Hong
Kong and Singapore Asian Currency Units (ACUs) for South East Asia,
Bahrain and Lebanon for the Middle East, Panama for Latin America and
Luxembourg for Europe.
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Booking OFCs – Booking OFCs do not engage in the regional
intermediation of funds, but rather serve as registries for transactions
arranged and managed in other jurisdictions. These OFCs are sometimes
referred to as tax havens and include most Caribbean OFCs.
Activities of OFCs
OFCs conduct a wide range of business, chiefly banking, but also,
insurance, securities transactions, trusts, and some non-financial activities
such as shipping registries.
Offshore banks deal mostly with other financial institutions and transact
wholesale business denominated in currencies other than that of the
country hosting the OFC. Offshore banking is carried out typically
through offshore establishments, which are offshore branches or
subsidiaries. Offshore branches are legally indistinguishable from parent
banks onshore, which facilitates intra-branch transfers. Shell branches or
booking offices are a particular case of offshore branches. They collect
deposits from various markets and channel them for various uses as per
dictates of their parents. Offshore activities may also take place through
what are called parallel-owned banks which are banks established in
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different jurisdictions that, while having the same owner(s), are not
subsidiaries of one another.
Offshore banks engage, inter alia, in eurocurrency loans (including
syndicated loans) and deposits, the underwriting of eurobonds, and over-
the-counter (OTC) trading in derivatives for risk management and
speculative purposes. Eurocurrency transactions are the bulk of offshore
banking operations. These include transactions between banks and the
original depositors, between banks and ultimate borrowers, and between
banks themselves on the inter-bank market. The underwriting of
eurobonds floated in international capital markets is also a significant part
of offshore banking activities. Private banking is a major service offered
to high net worth persons. Specialised services provided include asset
management, estate planning, foreign exchange trading, custodian and
trustee services.
Another area which has seen major growth in recent years has been the
setting up of Special Purpose Vehicles (SPVs) in the OFCs which are used
by banks for asset securitization and by non-financial corporations to
lower the cost of raising capital by utilisation of the tax advantages.
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II
Trends in Regulation of Offshore Banking
Since offshore banking emerged and grew in response to restrictive
regulatory regimes, there are certain inherent risks that can potentially
affect international financial stability. Three can be readily identified.
First, the contagion effect with the increasing integration of financial
markets worldwide and the explosive growth in cross-border capital flows,
problems in a bank in a OFC can be transferred rapidly to other market
jeopardising the stability of those markets. Second, the lack of reliable
data on activities in OFCs may hinder effective supervision. Third,
competitive liberalisation may lead to lowering regulatory standards in
OFCs in order to attract a higher share of global business.
Internationally regulators have been addressing the systemic issues posed
by offshore banking. The `Basle Concordat’ of 1975 was implemented on
best efforts basis for almost two decades. The bankruptcy of Bank of
Credit and Commerce International (BCCI) in 1992 hastened the adoption
of international supervisory standards. BCCI was a landmark in the sense
that thereafter, it has become difficult for a bank incorporated in a
jurisdiction with limited domestic market to carry on business in other
countries. The standards adopted by the Basle Committee for Banking
Supervision are as follows:
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• All international banks should be supervised by a home country
authority that capably performs consolidated supervision;
• The creation of cross-border banking establishments should receive the
prior consent of both the host country and home country authority;
• Home country authorities should possess the right to gather
information from their cross-border banking establishments;
• If the host country determines that any of these three standards is not
being met, it could impose restrictive measures or prohibit the
establishment of banking offices.
This was followed by the Report of a Working Group of the Basle
Committee which, inter alia, aims at improving access of home and host
regulators to data necessary for effective consolidated supervision and
ensuring all cross border banking operations are subject to home and host
supervision. Subsequently there have been several international and
regional supervisory and regulatory initiatives. These are aimed, inter alia,
at curbing involvement of OFCs in financial crime such as money
laundering, tax evasion, lax financial regulation including inadequate
supervision.
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Financial Stability Forum (FSF) set up a Working Group on OFCs (report
published in 2000) to review the uses and activities of OFCs and their
significance for global financial stability. FSF’s approach has been to
develop and implement standards internationally ensuring cross-border
cooperation. Compliance by various OFCs is also sought to be assessed as
well as means of incentivising compliance. The International Monetary
Fund (IMF) was brought in to carry out assessments of the OFCs and such
a programme has since become a standard part of IMF’s financial sector
work. As per latest data available, 41 of the 44 OFCs have been assessed.
While publication of assessments is voluntary, a large majority have opted
to publish the reports. The assessments have been largely `Module 2’
assessments, i.e. the observance of supervisory and regulatory standards in
the banking sector, effectiveness of the anti-money laundering and
combating the financing of terrorism. Some OFCs have voluntarily
subjected themselves for a more comprehensive assessment of risks to
macro economic stability on account of the vulnerabilities of the domestic
financial system.
The Financial Action Task Force (FATF) was established to help protect
financial systems from money laundering, drug related, financial crime.
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Regional groups have also been formed. A statement of best international
practices to combat money laundering has been published. OECD has also
been in the forefront creating several fora to step up international
cooperation.
III Offshore Banking in the Indian context
India has made a cautious beginning in offshore banking by permitting for
the first time Offshore Banking Units (OBUs) to be set up in Special
Economic Zones (SEZs). The SEZs have been set up with a view to
providing an internationally competitive and hassle free environment for
export production. SEZs will be specially delineated duty free enclave and
deemed to be a foreign territory for the purpose of trade operations and
duties / tariffs so as to usher in export-led growth of the economy. The
OBUs virtually would be foreign branches of Indian banks located in
India. These OBUs, inter alia, would be exempt from reserve requirements
and provide access to SEZ units and SEZ developers to international
finances at international rates. The Reserve Bank of India (RBI) has
permitted banks operating in India, whether Indian, public/private sector
or foreign, to set up OBUs in the SEZs. The OBUs would carry out
essentially wholesale banking operations. The OBUs will be set up as
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branches of the banks and therefore no separate assigned capital will be
required. All prudential norms applicable to overseas branches of Indian
banks would apply to OBUs. Thus, the necessary risk management
practices that are in vogue internationally, would have to be adopted by
the OBUs. The OBUs will be regulated and supervised by RBI. They will
be required to scrupulously follow “Know Your Customer” and other anti-
money laundering directives of RBI from time to time.
Unlike the OFCs in other developing countries which conduct offshore
banking in a significant manner, the OBUs in India have a limited
mandate. In fact, the approach appears to be facilitating the SEZ policy
rather than introducing offshore banking in India. This is in line with the
cautious policy stance adopted by the regulators in regard to the opening
up of the financial sector. Notwithstanding the limited scope for offshore
banking in the light of the relevant regulations, many Indian banks have
set up OBUs in SEZs. Available feedback is encouraging.
Over the years, India has tightened the legal framework to combat money
laundering and other cross border financial crime. These include the
Prevention of Money Laundering Act 2002, passed keeping in view the
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FATF deliberations and recommendation and international initiatives at
the United Nations and others. There are other laws such as The
Smugglers and Foreign Exchange Manipulation (Forfeiture of Property)
Act of 1976, The Code of Criminal Procedures 1973, Prevention of
Corruption Act, 1988, The Narcotic drugs and Psychotropic Substances
Act of 1985.
IV
Way Forward
In general, the regulatory regime in respect of offshore banking may be
expected to move forward on the basis of following four broad principles:
• First, consolidated supervision of banking operations through greater
co-operation between home country and host country regulators;
• Second, higher transparency with reference to supervisory systems and
programmes including dissemination of guidelines, publications of
data of OFCs;
• Third, technical assistance to upgrade regulatory systems, supervisory
policies and procedures through adoption of `best in class’ processes
and policies.
• Fourth, setting up systems for independent monitoring of activities of
OFCs and complying with supervisory standards.
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What is the scope for offshore banking in India? The favourable factors
for an OFC in India are well known. These include availability of skilled
and quality banking, legal professionals, vastly improved
telecommunication systems ensuring connectivity, the time zone
advantage. The benefit by way of fillip to local economy is also well
understood. However, clearly the regulatory regime governing it would be
critical. Accordingly the proponents of offshore banking would need to
address the key concerns of the regulator. Apart from the apprehension of
offshore banking being used for dubious ends and in financial crime, the
regulator would also be concerned about the systemic risks to the financial
system. It would perhaps not be inappropriate to evolve a regulatory
framework with a road map for informed public debate. Such a framework
would need to address issues such as
• First, should only offshore banking be permitted or other activities
within the umbrella of an OFC? Some of the other activities may
appear as meeting specific needs such as insurance, fund management,
trusts, etc.
• Second, for an OFC being set up should there be a single regulator for
all the activities of the OFC or different regulators mirroring the
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pattern in the corresponding onshore sub sectors? Also, should there a
single regulator for onshore and offshore banks?
• Third, should there licensing of firms in the OFC as it is currently
stipulated for OBUs in SEZs? Or should it be simple incorporation as
is the practice in most OFCs? Or should licensing be restricted to
financial intermediaries?
• Fourthly, granted that licensing would be required for OBUs, who
would be the eligible parties – not just banks operating in India as per
current policy, but also foreign banks, their subsidiaries/ affiliates?
What would be the permissible activities? Here again the regulator
would need to strike a balance between the fundamental objective of
ensuring financial stability and the business growth compulsions of the
OBUs. For instance, if private banking were to be permitted, the
requirements of confidentiality would need to temper the anti-money
laundering safeguard measures.
The RBI is today well respected in the international community as a
proactive regulator in the adoption of international standards and the
maintenance of financial stability while at the same time, aiding
development and growth. A slew of policies adopted by RBI in the last
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few years have been aimed at strengthening the banking system. These
include adoption of prudential norms, consolidated supervision, connected
lending, using technology to upgrade settlement systems, payment
systems, widening and deepening the various segments of the financial
markets, the unrelenting emphasis on upgradation of risk management
systems of financial intermediaries. The gradualist approach to financial
liberalisation has paid rich dividend. The way forward appears to involve
at the first step, an assessment of the robustness of the existing legislative
and regulatory framework may be done keeping in view the principles of
cross border cooperation, information sharing transparency, ongoing
monitoring. Perhaps certain overseas jurisdictions with whom India can
have reciprocal arrangements can be identified, that will ensure proper due
diligence while licensing OBUs and subsequent supervision. In sum, the
question before us may not whether to have an OFC, but how can we set
up a well regulated OFC that will be beneficial to the Indian economy.
Thank you.
(The views expressed in this paper are technical and do not represent the
views of the institution to which the author belongs).
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Table1 : Offshore Banks : Regulatory Framework in Selected Offshore Financial Centers
Offshore Financial
Center
Activities and Restrictions
Prudential
Regulations
Tax Privileges
Role of Regulators
Anguilla
Both private and public
companies
may
operate
onshore and offshore. All four
domestic banks offer offshore
banking services
n/a
No taxes are
levied
Offshore (and
onshore) banks are
under the oversight
of the Offshore
Finance Committee
chaired by the
Governor with
representatives of
both the
Government and
private sector.
The Eastern
Caribbean Central
Bank does not
supervise the
offshore sector.
Antigua &
Barbados
Offshore banks maybe legally
established
under
the
International Business Center
(IBC) Act (1982) and are
defined
as
corporations
licensed to carry out banking
business in currencies other
than those of Caricom.
Minimum
paid-in
capital is US $ 1
million.
Licensing
includes information
on
shareholders,
directors, and officers
with
satisfactory
evidence
that
the
latter
have
the
necessary education
and experience, and
recent
financial
information on the
applicant.
Offshore banks must
submit
quarterly
returns and an annual
audit
must
be
submitted
to
the
Inspector of Banks in
the
Ministry
of
Finance, which has
the ability to carry
out
on-site
inspection.
Offshore
banks
have a 50 year
reprieve
from
taxes on profits.
There
are no
income
,capital
gains, or other
wealth tax
on
individuals.
Offshore banks are
regulated by the
Supervisor of
Banking and Trust
Corporations and
the Ministry of
Finance.
The Eastern
Caribbean Central
Bank does not
supervise the
offshore sector.
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Bahrain
Deposits from nonbank
institutions are allowed only if
they are atleast equivalent to
US $ 50,000.
Offshore banks cannot extend
loans to residents of Bahrain;
cannot offer current accounts.
Locally incorporated
offshore and onshore
banks must follow the
same rules.
Offshore institutions are
required to disclose fully
their ownership structure.
They are subject to
regular reporting
requirements to the
Bahrain Monetary
Authority (BMA) on a
monthly, quarterly,
semiannual and annual
basis. Prudential
requirements are applied
on a consolidated basis.
Taxation is
minimal.
Offshore banks must
be licensed by the
BMA, which also
supervises them.
A deposit insurance
scheme is in place for
all commercial banks.
The BMA has the
ability to provide
lender of the last
resort (LOLR)
facilities to onshore
banks. Offshore
banks are excluded
from LOLR support.
Barbados
Offshore banks must be
licensed under the Offshore
Banking Act of 1979 as an
eligible company under the
Companies Act or as a
qualified foreign bank.
Offshore banks are allowed to
do business with residents
such as the international
business companies (IBC) and
the foreign sales corporations
(FSC).
Prior to licensing
supervisors investigate
the applicants, the net
worth of principals and
capital adequacy, as well
as background
information on
shareholders, directors
and senior officers.
Applicant institutions
must provide financial
statements from
shareholders controlling
more than 5% of voting
stock, information on
corporate structure and
approval of the parent
supervisor.
Offshore banks are
required to submit
quarterly returns , the
Basle capital adequacy
criteria for country and
individual risk exposure
apply.
Low tax
jurisdiction with
an extensive
web of bilateral
tax treaties.
Offshore banks must
be licensed by the
Central Bank of
Barbados, which also
regulates and
supervises them.
Belize
IBCs are allowed to carry out
offshore banking with
appropriate licence.
IBCs are prohibited from
owning shares or assets in a
locally incorporated company.
They cannot sell shares or
borrow from a Belizean
resident.
N/a
Taxation is
minimal. A one-
off fee of US $
100 is levied
with registered
capital upto US
$ 50000.
Offshore banks must
be licensed by the
Central Bank of
Belize under the 1996
Offshore Banking
Act. The Central
Bank also supervises
offshore banks.
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Malaysia
Offshore banks are allowed to
operate only in the
International Offshore
Financial Centre (IOFC) on
the island of Labuan off
Borneo.
Offshore banks cannot accept
checking accounts and extend
loans denominated in the
Malaysian currency to both
non-residents and Malaysian
residents.
No exchange controls are
in place.
There are stringent bank
secrecy rules.
Taxation is
minimal.
Offshore banks
operating in the IOFC
are not regulated by
the Banking and
Financial Institution
Act of 1989, but are
governed by separate
legislation monitored
by a regulatory body
known as the Labuan
Offshore Financial
Services Authority.
Singapore
Typically offshore banking is
operated through Asian
Currency Units (ACUs).
These are operational units
whose function is to conduct
business in the Asia Dollar
market. ACUs may also be
operated by onshore
commercial banks and
merchant banks. In these
cases, ACUs are distinct
accounting entities separately
licensed by the Monetary
Authority of Singapore (MAS)
ACUs accept deposits and
make loans in foreign
currencies and are prohibited
from doing business
denominated in Singapore
dollars. They cannot accept
time deposits of less than SGD
250000; operate savings
account; have more than one
location (no branches).
Total credit facilities to
Singapore non-bank
customers must be less than
SGD 50 million.
ACUs are exempt from
several prudential
regulations, most notably
the reserve requirements
(normally 6 percent), the
minimum liquid asset
ratio (normally not less
than 18 percent),
limitations on
investments , limitation
on acquisition of
immovable property and
some of the limitations
on credit facilities (limits
to a single borrower and
related party or parties).
Foreign ACUs are
required to provide a
guarantee from their
parent institutions
ensuring liquidity on
demand to the ACU
should it run into
difficulties.
ACUs are required to
provide detailed financial
statements to the MAS
on a monthly basis.
ACUs are taxed
at a
concessionary
rate of 10
percent (normal
corporate tax
rate is 26
percent)
There is no
withholding or
income tax on
non resident
ACUs
depositors.
ACUs must be
licensed by the MAS
, which also
supervises them .
Inspections on the
accounts of the ACUs
are carried out on a
regular basis.
There is no formal
deposit insurance
scheme. The MAS
has ability to act as
lender of last resort,
but not an obligation
to do so.
In 1996, the Banking
Act was amended to
allow foreign
regulatorsto inspect
the Singaporean
branches of banks
under their over sight
.
Thailand
Allowed to engage in lending
and deposit taking activities in
foreign currencies with
nonresidents. And allowed to
engage in treasury and
corporate finance activities.
Cannot engage in transactions
denominated in Bath with
Thai residents.
N/a
Offshore banks
are taxed at a
concessionary
rate of 10
percent
(corporate
income tax is 30
percent)
Offshore banks are
licensed by the
Central Bank and are
subject to
supervision.
A deposit insurance
scheme for Baht
deposits is in place. It
is not open to
offshore banks.
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The Bahamas
Non-resident companies,
including offshore banks are
allowed to operate freely in
foreign currencies.
Exchange control approval is
required to operate Bahamian
dollar accounts.
Under the Caricom Bank
Supervision
Harmonization Project
(CBSHP), offshore banks
are subject to application
requirements, minimum
required levels of capital
and reserves, and external
audits. Like onshore
banks, offshore institutions
must meet requirements in
the areas of directors’
qualifications, information
disclosure and reporting.
No income,
capital or
withholding
taxes apply.
The Central bank of
the Bahamas
supervises offshore
banks.
The
Philippines
Foreign banks can operate
offshore banking units
(OBUs).
OBUs are permitted to
conduct all normal banking
transactions with non-
residents in any foreign
currency.
Deposits from nonbank
institutions are allowed only if
they are atleast equivalent to
US $ 50000.
Cannot conduct transactions
denominated in pesos.
Transactions in foreign
currency with residents are
strictly limited.
Locally incorporated
offshore and onshore
banks must follow the
same rules.
In order to gain approval
from the Central bank for
the establishment of an
OBU, foreign banks must
provide a guarantee of
financial support to the
OBU if need be and
promise to train local
citizens in various
international banking
positions.
Taxation is
minimal
Offshore banks are
licensed by the
Central bank and are
subject to
supervision.
A Deposit Insurance
scheme (DIS) for
peso deposits is in
place.
It is unclear whether
offshore banks may
participate in the DIS.
United States
of America
U.S banks are allowed to
engage in cross border
transactions, including
offshore banking through head
office international
departments, foreign branches,
foreign subsidiaries and
affiliates and international
banking facilities (IBFs).
U.S. banks are allowed to
participate abroad in
investment banking and other
activities permitted to banks in
many countries, but still
prohibited at home.
Head office international
departments are subject to
U.S. regulations of their
international lending
exposure under the
International Lending
Supervision Act.
IBFs are subject to Fed
authorization and are
regulated and supervised in
the same way as head
office international
departments.
Reserve requirements are
applied on foreign
currency deposits held
with IBFs when these
funds are transferred to the
U.S. parent institutions or
lent to U.S. residents.
n/a
The Office of the
Comptroller of the
Currency (OCC) and
the Fed are largely
responsible for
supervising the
international
operations of U.S.
banks. They carry out
off-site inspections of
offices abroad.
The U.S. Deposit
Insurance Scheme
does not apply to
IBFs.
Source: IMF Working Paper, WP/99/5 “Offshore Banking: An Analysis of Micro and Macro-
Prudential Issues”, January 1999.