Offshore bank - An introduction

Offshore banks are banks wherein a majority of their depositors are located in a jurisdiction outside their own country. Unlike is the modern perception these banks are not only located in the smaller tax havens, but some of the bigger countries like the United States and Hong Kong also have banks which get a majority of their dealings from depositors in a foreign country.

Origin - This term was originally came from the fact that the 'channel islands' were located 'offshore' from the United Kingdom[1], and a lot of people in the UK used to deposit their money there in order to attain tax benefits, as these islands had a more favorable tax structure. Even till today most of these so called 'tax havens' are small island nations, such as Mauritius, the Caymen Islands, Bermuda etc. however, we should be clear that such a usage of the term 'offshore' is merely figurative as these offshore banks also exist in land locked countries such as Luxemburg and Andorra [2]. In fact, Swiss banks are also one such example.

What makes these offshore banks sought after?

First and foremost is the fact that these banks secure the privacy of the depositor. As we know today, most banks, especially in the United States; do not essentially respect depositor privacy, as they disclose all information about the clients to anyone (and not just the government) who makes an attempt to find out. This is where these offshore banks differ. Absolute secrecy is maintained by these banks with regards to their clients. The Swiss bank example can be given in this instance. These banks do not disclose any information about their clients until and unless proof is produced, say by a government agency, of any sort of money laundering, fraud or any other form of financial crime[3], for which depositor identity or information needs to be disclosed.

Secondly, these banks are generally located in tax havens, or places with a favorable tax structure. Hence these banks are a lucrative option for big companies seeking tax benefits. But, this also the cause of worry for a lot of governments, as they feel that this way they are losing out on a lot the tax which they would have otherwise earned.

Thirdly, these banks are generally located in countries which are and have been politically and financially stable. This sort of eliminates any problems that may arise if a depositor is located in an unstable environment, where he runs the risk of his assets being taken over by the government and frozen as had happened in the Argentine economic crisis in 2001[4]. Political stability has other advantages as well, because such countries which have minimum governmental intervention[5] and can operate their banks at lower costs and provide higher interest rates.[6]

Fourthly, we have already mentioned that a lot of these offshore banks are in small island nations, usually cut off from the main stream world. These banks, therefore, give these small countries an opportunity to merge with the rest of the world, as they can participate directly in their economies by sourcing investments etc, and can help distribute the world finance from the bigger stronger economies to the smaller developing economies. [7]

What are the disadvantages of these offshore banks?

Firstly, these offshore banks mostly are in remote locations which are not easily accessible. Hence, a depositor is made to incur excess costs in order to travel to these locations for his banking purposes. Thus regular day to day banking becomes difficult. However this is a problem of the past, as the internet connects these banks very efficiently and telephone and email makes online banking easy. [8]

Secondly, the usual perception of offshore banking is that it sort of gives a green signal for all sorts of financial crimes and makes it easy for money laundering etc. Post 9/11 a lot of critiques of the offshore banks have felt that these banks have helped terrorism and other form of international crime by non state actors and various terrorist outfits.[9]

Thirdly, these banks usually are of help to the richer members of society, as most middle income and low income group individuals find it very expensive to set up and maintain these accounts.[10]

Offshore finance - an economic/political approach

So as have discussed earlier, an offshore bank is essentially a bank which gets majority of its dealings from jurisdiction outside of its own country. It is not necessary that a main stream economy could not house an offshore bank. Countries like United States of America and Hong Kong have off shore banks. However, we essentially restrict this discussion to those offshore banks which are in smaller countries, such as Luxemburg, Bermuda, Cayman Islands, Mauritius etc, which enjoy certain tax and excise benefits. So, how are these countries different to the bigger ones? They are different because in these smaller countries, most of their budget and revenue come from these offshore banks[11]. They are one of the main pillars of their economy.

In the earlier part of the 1990's and through that decade a lot of question had arisen about the safety of these offshore banks. Especially in this day and age of terrorism it was questioned that a lot of these banks left open a lot of loopholes for illegal money to seep in. It is true that a in during the 1980's and early 1990's these banks allowed a lot of legal money and black money. However today, because of a lot of programs of the International Monetary Fund and OECD, the regulations that governed these offshore banking institutions have become very rigorous[12]. Hence, because of the implementation of these regulations the tax havens are a boon the economy as they provide a lot of 'financial and tax competition'[13].

How do offshore banking institutions provide financial and tax competition

Taxes have always been looked at in an archaic way. The more the tax the worse it is for the customers. But this is not always the truth. In 2006 France had almost cut down its taxes from by 10%, after Ireland had cut down its taxes drastically in the past, an act which drew a lot of flak from the other European countries. This act of the then French President Jacques Chirac shows that the lowering of taxes by one country will still lead to a tax competitive environment, and sort of acts as proof that most countries do it.

These tax cuts and tax advantages also prevent the bigger countries like the United States from becoming big and gloated with excess tax money.[14]

Also, there is nothing in modern day taxation to act as evidence of a 'race to the bottom'[15]. Though the taxes are being reduced at a greater rate than ever before, there seems to be no correlation between cutting taxes and the government revenue. How is that possible? The lowering of taxes lowers the incidence of tax evasion, as people are ready to pay the now lowered taxes, as it is less burdensome[16]. Also, lowering of taxes has made the big countries more vigil, and they have begun plugging the loopholes, which assisted those evading tax. Also in the last 15 years or so the entire world economy has by large been on a boom, except for the recession hit 2007-2008, hence, providing greater stimulus to the economy and not letting the lower tax rates affect government revenue, by and large.[17]

Tax havens are hence clearly a form of tax competition. A lot of reports suggest that the bigger economies often oppose and criticize these tax havens. This may not necessarily be correct. These tax havens exist because the bigger countries let them exist. If they really did want to shut them down they could have easily done it, all that would have been needed is for the so called big countries to coordinate their tax systems, in such a way that there would be no reason to go to these tax havens[18]. But they chose not to do that. It is therefore sometimes suggested that there does exist some sort of a symbiotic relationship between these bigger and smaller nations.[19]

Another concern that has arisen is with regard to money laundering - it has always been clear that money laundering affects economic stability. In 1990, there was a detailed debate between the G7 countries with regard to the advantages and repercussions of globalization[20]. There were definitely a lot of good that would come of globalization but at the same time there would be a lot of risks involved too - Financial stability and financial crime are some of them[21]. If one part of the world suffers a bank crisis it could spread to the other parts of the globe as well, as we have seen in the very recent global melt down which started in the United States but moved to the rest of the world. Unlike issues such as tax competition, which still has a lot of opposition, issues like money laundering and financial crime are universally looked at as a negative thing[22]. What this has essentially done is that it has encouraged all countries to call for a set of uniform regulations to govern these offshore banks, because in the past there were a lot of economies which were not as well regulated, in fact this regularization is still to be achieved properly as some economies are still not well regulated[23]. However this is changing now, because all countries have to have well regulated economies, else they run the risk of being marginalized from the main stream banking system of the world, which would in turn will deprive them of their livelihood[24]. The tax havens, such as Bermuda, Cayman islands, etc which are where a lot of these specialized offshore banks operate, are also as well regulated as the bigger economies. It is important to note that money laundering happens everywhere. It is not something which is restricted to only offshore banks. It happens in both offshore as well as onshore banks. A lot of the smaller offshore banks often put forth the argument that the bigger banks try to protect their share in the market by giving a bad reputation to these smaller offshore financial institutions, as they are now in direct competition with them[25], but one can possibly know where this argument stems from. It is because there was a time, say about 20 years back, when these offshore banks were not well regulated and were sort of an outlet for a lot of these illegal activities, but as I have already mentioned earlier, these are a thing of the past as these banks are all very well regulated and the IMF and the OECD has a good watchful eye on them. Hence the concern that money laundering has been made simpler by these offshore banks is not well founded.

The Enron argument

One of the most often used examples to argue against these offshore banking institution is the Enron example. It is true that Enron did use these tax havens in order to gain tax benefits, by opening about 100's of companies in these tax havens, however the use of these Offshore financial institutions was not per se illegal, its how they did it that was illegal[26]. Enron was engaging in fraudulent activities either way, even in a proper legal regime like the US. What a lot of people feel is that this political concerns against offshore financial institutions was mostly because of the fact that politicians in the US were suspicious that these tax havens were sort of causing the US to have a major tax deficit because, as a result of a boom of these offshore banks[27]. Hence, this worry caused them to blame to the offshore banks, because it is definitely easier for them to blame someone on the outside than someone within their economy[28].

'Offshore financial institutions are illegal and bad' - A myth?

There is a strong belief surround the entire banking/business world that the offshore banking units such as the ones in Bermuda, the Cayman islands etc are a hub for all sort of illegal banking frauds and other financial crimes. The purpose of this section is to break that myth and to show that these offshore banking centers are not what they are made out to be but are in fact a boon to the world economy.

First myth - The offshore banking institutions only cater to criminals:

Richard Rann in one of his articles in the Washington Times[29] had once asked the question that if one was to pick a place to put his money, would be rather have his money put into a bank run by 'incompetents' and 'criminals' in a place with substantive law and order problems or put his money in a bank which is run by 'honest' and 'competent' people in a country which as a stable legal structure and where the concept of 'rule of law' exists[30]. He stated that, contrary to a lot of beliefs these countries were in fact governed really well. They had proper judicial systems and legal structures and were very well administered[31]. Most of the money that is held in these banks was institutionally held rather than by private individuals[32], as opening of an individual account was more tedious than opening an institutional account[33]. Thus the instances of individual money laundering and substantial part of banking crimes stand reduced. Countries like the United States, in the post 9/11 phase, began having individual agreements with some of these smaller island nations, the so called 'tax havens'. These agreements essentially needed countries like Cayman Islands etc. to disclose to the US administrate agencies[34] all information on US suspects. These agreements were essentially to act as an impediment to all forms of organized criminal activities like terrorism etc. Thus, these stringent measures make it very difficult for one to open an account in these offshore institutions in order to do illegal activities. In fact we see in today's world that most of the so called big nations have more instances of money laundering than these smaller offshore banks.

Second myth - All that these offshore banks do is encourage tax evasion:

Richard Rann trashes this myth as well. He says that instead of looking at this from a 'tax evasion' point of view it should be seen in a more positive light. He says that what these offshore banks do is that they provide a sort of a vault where large companies and big business houses can consolidate their money. These banks do not store money in hard form, it is generally electronically stored[35]. Most of the physical cash remains in the countries of the depositors. Since this money can be stored in these banks without any sort of excessive taxations or regulations, they can be invested productively all around the world, just by the click of a button through these electronically managed accounts.[36] What a lot of people call tax evasion is in fact the reason a lot of the big multi nations all over the US and other bigger countries are able to protect the retirement income of most of their employees[37], as a part of their investments are managed in these banks and put to better and more lucrative uses[38]. A favorable tax structure is almost imperative, because if there were very high taxes on capital, a lot of people would shy away from investments as they would hardly have any savings, hence impeding economic growth and also slowing down the creation of jobs[39].


Offshore banking in India

India has for long debated the setting up of offshore banks. There a lot of people who have argued for this. In fact Mumbai was considered extremely suitable for an offshore bank because of the availability of good infrastructure, good telecommunication, ample opportunity for finding able personnel and presence of many banks already engaging in international banking there[40].The Sodhani committee on Foreign Exchange reforms has recommended that offshore banks in Special Economic Zones, as are best suited for such banks[41]. It waits to be seen when and how will these banks come into India. Many feel that the sooner it is the better it is for India.

Hence, in the course of this paper we did look at the various aspects of Offshore finance and we can now safely conclude that the advent of offshore banks are inevitable, until and unless big countries coordinate their tax systems. These banks act as a very important and basic pillar of globalization.

  1., last accessed on 2nd April, 2010
  2. Ibid
  3. Dough Casey, Offshore Accounts - No longer an easy option, as available on, last accessed on 2nd April, 2010
  4. Supra note 1
  5. Excessive political intervention and low interest rates often share a positive correlation, as many economists believe that excessive governmental control causes interest rates to drop.
  6. Supra note 1
  7. Ibid
  8. Ibid
  9. Ibid
  10. Ibid
  11. Ibid
  12. Ibid
  13. Ibid
  14. Ibid
  15. Ibid
  16. Ibid
  17. Ibid
  18. Ibid
  19. Ibid
  20. Ibid
  21. Ibid
  22. Ibid
  23. Ibid
  24. Ibid
  25. Ibid
  26. Ibid
  27. Ibid
  28. Rann Richard, Offshore Finance, as available on, last visited on 2nd April, 2010
  29. Ibid
  30. Ibid
  31. Ibid
  32. Ibid
  33. Mainly the US Internal Revenue Service and the U.S.Department of Justice.
  34. Ibid
  35. Ibid
  36. Ibid
  37. Ibid
  38. Ibid
  39. Jeevanandan C, Offshore banking: A lucrative proposition, as available on, last visited on 2nd April, 2010.
  40. Ibid

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