Offshore bank

An offshore bank is a bank located outside the country of residence of the depositor, typically in a low tax jurisdiction (or tax haven) that provides financial and legal advantages. These advantages typically include some or all of

strong privacy (see also bank secrecy, a principle born with the 1934 Swiss Banking Act)
less restrictive legal regulation
low or no taxation (i.e. tax havens)
easy access to deposits (at least in terms of regulation)
protection against local political or financial instability

While the term originates from the Channel Islands "offshore" from Britain, and most offshore banks are located in island nations to this day, the term is used figuratively to refer to such banks regardless of location (Switzerland, Luxembourg and Andorra in particular are landlocked).

Offshore banking has often been associated with the underground economy and organized crime, via tax evasion and money laundering; however, legally, offshore banking does not prevent assets from being subject to personal income tax on interest. Except for certain persons who meet fairly complex requirements^[1], the personal income tax of many countries^[2] makes no distinction between interest earned in local banks and those earned abroad. Persons subject to US income tax, for example, are required to declare on penalty of perjury, any offshore bank accounts—which may or may not be numbered bank accounts—they may have. Although offshore banks may decide not to report income to other tax authorities, and have no legal obligation to do so as they are protected by bank secrecy, this does not make the non-declaration of the income by the tax-payer or the evasion of the tax on that income legal. Following September 11, 2001, there have been many calls for more regulation on international finance, in particular concerning offshore banks, tax havens and clearing houses such as Clearstream, based in Luxembourg, being accused of being a crossroads for major illegal money flows.

Defenders of offshore banking have criticised these attempts at regulation. They claim the process is prompted, not by security and financial concerns, but by the desire of domestic banks and tax agencies to access the money held in offshore accounts. They argue that offshore banking offers a competitive threat to the banking and taxation systems in developed countries, and that OECD countries are trying to stamp out competition.

Advantages of offshore banking

Offshore banks provide access to politically and economically stable jurisdictions. This may be an advantage for those resident in areas where there is a risk of political turmoil who fear their assets may be frozen, seized or disappear (see the corralito for example, during the 2001 Argentine economic crisis). However, developed countries with regulated banking systems offer the same advantages in terms of stability.

Some offshore banks may operate with a lower cost base and can provide higher interest rates than the legal rate in the home country due to lower overheads and a lack of government intervention. Advocates of offshore banking often characterise government regulation as a form of tax on domestic banks, reducing interest rates on deposits.

Offshore finance is one of the few industries, along with tourism, that geographically remote island nations can competitively engage in. It can help developing countries source investment and create growth in their economies, and can help redistribute world finance from the developed to the developing world.

Interest is generally paid by offshore banks without tax deducted. This is an advantage to individuals who do not pay tax on worldwide income, or who do not pay tax until the tax return is agreed, or who feel that they can illegally evade tax by hiding the interest income.

Some offshore banks offer banking services that may not be available from domestic banks such as anonymous bank accounts, higher or lower rate loans based on risk and investment opportunities not available elsewhere.

Offshore banking is often linked to other structures, such as offshore companies, trusts or foundations, which may have specific tax advantages for some individuals.

Many advocates of offshore banking also assert that the creation of tax and banking competition is an advantage of the industry, arguing with Charles Tiebout that tax competition allows people to choose an appropriate balance of services and taxes. Critics of the industry, however, claim this competition as a disadvantage, arguing that it encourages a "race to the bottom" in which governments in developed countries are pressured to deregulate their own banking systems in an attempt to prevent the offshoring of capital.

Note: Offshore banking no longer always means "private".

Most (maybe all) traditional jurisdictions are no longer suitable for asset protection, privacy and confidentiality. Well-known, traditional offshore havens, will now willingly divulge information upon request.

Disadvantages of offshore banking

Offshore banking has been associated with the underground economy and organized crime, through money laundering. Following September 11, 2001, offshore banks and tax havens, along with clearing houses, have been accused of helping various organized crime gangs, terrorist groups, and other state or non-state actors.

The existence of offshore banking encourages tax evasion, by providing tax evaders with an attractive place to deposit their hidden income.

Offshore jurisdictions are often remote, so physical access and access to information can be difficult. Yet in a world with global telecommunications this is rarely a problem for customers. Accounts can be set up online, by phone or by mail.

Developing countries can suffer due to the speed at which money can be transferred in and out of their economy as "hot money". This "Hot money" is aided by offshore accounts, and can increase problems in financial disturbance.

Offshore banking is usually more accessible to those on higher incomes, because of the costs of establishing and maintaining offshore accounts. The tax burden in developed countries thus falls disproportionately on middle-income groups. Historically, tax cuts have tended to result in a higher proportion of the tax take being paid by high-income groups, as previously sheltered income is brought back into the mainstream economy [2]. The Laffer curve demonstrates this tendency.

European Savings Tax Directive

In their efforts to stamp down on tax evasion EU governments agreed to the introduction of the Savings Tax Directive in the form of the European Union withholding tax in July 2005. A complex measure, it forced EU resident savers depositing money in offshore banks to choose between forfeiting tax at the point of payment, or allowing notification by the offshore banks to tax authorities in their country of residence. It is the intention of the EU authorities that offshore banks in an increasing number of jurisdictions should be affected.[3]

Furthermore the rate of tax deducted at source will rise in 2008 and again in 2011, making disclosure increasingly attractive. Savers' choice of action is complex; tax authorities are not prevented from enquiring into accounts previously held by savers which were not then disclosed.

Recent reports in The Times newspaper suggest that the Inland Revenue service in the United Kingdom will continue to press banks for details of customers' offshore accounts which have not been properly declared on their tax returns even where the bank is in a jurisdiction which has agreed to impose withholding tax instead of exchanging information.[4]

Banking services

It is possible to obtain the full spectrum of financial services from offshore banks, including:

Not every bank provides each service. Banks tend to polarise between retail services and private banking services. Retail services tend to be low cost and undifferentiated, whereas private banking services tend to bring a personalised suite of services to the client.

Statistics concerning offshore banking

Offshore banking is an important part of the international financial system. Experts believe that as much as half the world's capital flows through offshore centers. Tax havens have 1.2% of the world's population and hold 26% of the world's wealth, including 31% of the net profits of United States multinationals. According to Merrill Lynch and Gemini Consulting's “World Wealth Report” for 2000, one third of the wealth of the world's “high net-worth individuals”—nearly $6 trillion out of $17.5 trillion—may now be held offshore. Some $3 trillion is in deposits in tax haven banks and the rest is in securities held by international business companies (IBCs) and trusts.

The IMF has said that between $600 billion and $1.5 trillion of illicit money is laundered annually, equal to 2% to 5% of global economic output. According to Celent, European financial services firms will drastically increase their use of offshore resources, with up to 450,000 continental European financial services jobs moving offshore by 2010. ^[3]

Today, offshore is where most of the world's drug money is allegedly laundered, estimated at up to $500 billion a year, more than the total income of the world's poorest 20%. Add the proceeds of tax evasion and the figure skyrockets to $1 trillion. Another few hundred billion come from fraud and corruption. "These offshore centers awash in money are the hub of a colossal, underground network of crime, fraud, and corruption" commented Lucy Komisar quoting these statistics.^[1] Among offshore banks, Swiss banks hold an estimated 35% of the world's private and institutional funds (or 3 trillion Swiss francs), and the Cayman Islands are the fifth largest banking centre globally in terms of deposits. ^[4]

Regulation of offshore banks

In the 21st century, regulation of offshore banking is allegedly improving, although critics maintain it remains largely insufficient. The quality of the regulation is monitored by supra-national bodies such as the International Monetary Fund (IMF). Banks are generally required to maintain capital adequacy in accordance with international standards. They must report at least quarterly to the regulator on the current state of the business.

Since the late 1990s, especially following September 11 2001, there have been a number of initiatives to increase the transparency of offshore banking, although critics such as the Association for the Taxation of Financial Transactions for the Aid of Citizens (ATTAC) non-governmental organization (NGO) maintain that they have been insufficient. A few examples of these are:

The tightening of anti-money laundering regulations in many countries including most popular offshore banking locations means that bankers are required, by good faith, to report suspicion of money laundering to the local police authority, regardless of banking secrecy rules. There is more international co-operation between police authorities.
In the US the Internal Revenue Service (IRS) introduced Qualifying Intermediary requirements, which mean that the names of the recipients of US-source investment income are passed to the IRS.
Following 9/11 the US introduced the USA PATRIOT Act, which authorises the US authorities to seize the assets of a bank, where it is believed that the bank holds assets for a suspected criminal. Similar measures have been introduced in some other countries.
The European Union has introduced sharing of information between certain jurisdictions, and enforced this in respect of certain controlled centres, such as the UK Offshore Islands, so that tax information is able to be shared in respect of interest.

Joseph Stiglitz, 2001 Nobel laureate for economics and former World Bank Chief Economist, told to reporter Lucy Komisar, investigating on the Clearstream scandal:

"You ask why, if there's an important role for a regulated banking system, do you allow a non-regulated banking system to continue? It's in the interest of some of the moneyed interests to allow this to occur. It's not an accident; it could have been shut down at any time. If you said the US, the UK, the major G7 banks will not deal with offshore bank centers that don't comply with G7 banks regulations, these banks could not exist. They only exist because they engage in transactions with standard banks."^[1]

In the 1970s through the 1990s it was possible to own your own personal offshore bank; mobster Meyer Lansky had done this to launder his casino money. Changes in offshore banking regulation in the 1990s in the form of "due diligence" (a legal construct) make offshore bank creation really only possible for medium to large multinational corporations that may be family owned or run.

A series of articles published on June 23, 2006, by The New York Times, The Wall Street Journal and The Los Angeles Times revealed that the United States government, specifically the Treasury Department and the CIA, had a program to access the SWIFT transaction database after the September 11th attacks (see the Terrorist Finance Tracking Program) rendering offshore banking for privacy severely compromised.

Offshore financial centres

In terms of offshore banking centres, in terms of total deposits, the global market is dominated by two key jurisdictions: Switzerland and the Cayman Islands,^[5] although numerous other offshore jurisdictions also provide offshore banking to a greater or lesser degree. In particular, Jersey, Guernsey and the Isle of Man are known for their well regulated banking infrastructure. Some offshore jurisdictions have steered their financial sectors away from offshore banking, as difficult to properly regulate and liable to give rise to financial scandal.^[6]

List of offshore financial centres

Offshore financial centres include:

External links

Footnotes

^ Such as perpetual travelers
^ For example, the United States, France and Malaysia. In other countries it makes no difference so long as you are resident and domiciled there (for example, the United Kingdom)
^ Celent Report: According to figures published by Celent 10 May 2006. See also Offshoring in the European Banking and Securities Industries.
^ Bank Introduction
^ The most recent report of the Cayman Islands financial services regulator indicated that the jurisdiction had 570 licensed banks, holding US$1.26 billion in deposits.[1]
^ For example, despite being the largest offshore jurisdiction by some distance in terms of number of incorporated offshore vehicles, the British Virgin Islands has only ever licensed 7 offshore banks. This compares against hundreds in Switzerland, the Cayman Islands and (3rd in number of total banking licences) the Bahamas.

[1] Such as perpetual travelers

[2] For example, the United States, France and Malaysia. In other countries it makes no difference so long as you are resident and domiciled there (for example, the United Kingdom)

[Celent-3] Celent Report: According to figures published by Celent 10 May 2006. See also Offshoring in the European Banking and Securities Industries.

[4] Bank Introduction

[5] The most recent report of the Cayman Islands financial services regulator indicated that the jurisdiction had 570 licensed banks, holding US$1.26 billion in deposits.[1]

[6] For example, despite being the largest offshore jurisdiction by some distance in terms of number of incorporated offshore vehicles, the British Virgin Islands has only ever licensed 7 offshore banks. This compares against hundreds in Switzerland, the Cayman Islands and (3rd in number of total banking licences) the Bahamas.

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