Offshore banks operate on an offshore basis. Offshore banks provide services only to non-residents of the jurisdiction where such banks are established. For example a Belize-registered offshore bank can provide services to clients from any country, except to permanent residents of Belize. This is the main formal difference between offshore and onshore banks.

What is more important is the environment in which offshore banks operate. Offshore banks carry on banking and financial activities in an environment which is free of fiscal and exchange controls, i.e. tax havens or low tax areas, commonly referred to as offshore finance centers. These conditions normally also include favorable banking legislation which is considerably less strict than those in most onshore jurisdictions.

Offshore banks can be controlled by residents of any country in most offshore banking jurisdictions. It is much easier to obtain a banking license in an offshore location than in strictly controlled domestic jurisdictions. You can enhance your business structure and gain extra advantages compared to your competitors by establishing an offshore bank.

The Purposes of Offshore Banks

Offshore banks are used in many typical situations. Offshore banks are often established by already existing onshore banking or financial institutions for the following reasons:

Access international credit market

Access international correspondent account networks

Provide clients with tax effective loans

Provide clients with actual banking secrecy

Provide clients with other services that would be impossible in severely regulated onshore jurisdictions

Provide Letters of Guarantee

Accept deposits outside the controlled environment

Avoid strict debt-equity ratios and lending restrictions imposed by more severely regulated onshore jurisdictions

Avoid huge minimum capital requirements imposed by more severely regulated onshore jurisdictions

Operate in the securities market without limitations

By-pass intermediaries while carrying out certain financial operations

Minimize political risk (that could be higher in some East European countries for example)

Enhance group's image

Offshore banks are established not only by banking or financial institutions, but also by corporate groups to handle external borrowing or to consolidate the group's financial or banking transactions. For example, when your company is involved in international trade and financial resources are handled through an outside bank, it may seem quite reasonable to establish your own offshore bank. You may well want to use an offshore bank as a foreign or multi-currency management center. Frequently large, and very often, medium sized, companies have their own offshore banks, which handle their liquid assets and current accounts of their branches. Thus, if a group of your companies requires banking services, it really makes sense to establish your very own offshore bank as you can conduct all your transactions with regular clients or suppliers, provide Letters of Credit, etc. through your own bank. The activities of international finance companies also fall within the category of offshore banking. These activities may include external loan raising, provision of confirming finance to clients and group entities, discounting or factoring of the group and other debts, and tax effective corporate group's loans. The leasing of equipment through an offshore based captive finance company is another useful offshore banking concept. This activity may be for the purpose of providing vendor lease finance to group customers or to fund group asset acquisitions.

However, offshore banks are established also to satisfy the needs of small groups or even one person. Offshore banking is traditionally oriented towards fulfilling the needs of the wealthy.

Advantages

The advantages of offshore banks are two-dimensional. Both - the banking institution and its clients - benefit from the advantages of an offshore bank.

Low tax or tax free environment

Offshore banks are either tax exempt or taxes are reduced to several per cent of the amount of the profit. This enables an offshore bank not only to generate a better bottom-line but will also provide it with a stable operating base by avoiding the vagaries or contingencies of onshore fiscal policies. No taxes are levied at the source of income, e.g. on bank interest, dividends and other similar payments. Expenses are limited to administrative expenditures and annual dues necessary to renew an off-shore status. The earnings of the offshore bank from currency management, participation in syndicated loans, money market and securities dealings and deposit-taking activities can be protected from the high rates of income taxes applicable in domestic banks or financial institutions which may well be subject to interest withholding taxes imposed by the domestic fiscal authority. No taxes are levied at the source of income, e.g. on bank interest, dividends and other similar payments. Expenses are limited to administrative expenditures and annual fees necessary to renew an offshore status.

No exchange control

The absence of exchange control will obviously enable the offshore bank to move funds with a greater degree of freedom and flexibility than from within an exchange controlled area. The offshore bank should benefit from this enhanced flexibility by being able to conclude transactions promptly, particularly in volatile market conditions.

Less strict license requirements

The license requirements for offshore banks are simplified to a large extent and quite a lot of applicants are eligible for such a license. Unlike the majority of the countries throughout the world, a foreign applicant does not have to be a "world class bank" to get a banking license in an offshore jurisdiction. Such a license could be issued to a small bank, financial institution, trading company or even an individual.

More competitive interest rates

An offshore bank is able to increase its deposit base at a greater rate than its wholly onshore competitors. Its clients will benefit by receiving their interest income free of any withholding tax and the lower tax base of the offshore bank should enable it to be more competitive with its interest rates. If the client is also able to structure his own assets through an offshore trust or investment holding company then his interest income may also be free from tax in his domestic jurisdiction and his deposits not subject to onshore exchange controls.

Maximum confidentiality

Offshore banks provide the highest level of confidentiality. There are some cases, when an anonymous offshore company opens an anonymous account in an anonymous offshore bank. This way, triple-layered protection of confidential commercial information is achieved. Nominee owners and directors are often assigned to ensure anonymity.

Small amount of required equity capital

In offshore banking jurisdictions, it is significantly lower than in the onshore locations of the world. For the majority of businessmen it is the only opportunity to establish a foreign commercial bank, since other possibilities are unacceptable due to the requirement of high capital, personnel, reputation and business-planning of the bank. It is no secret that by establishing an offshore bank large companies and banks can keep their expenses low and business opportunities are boosted.

No reserve requirements and liberal bank control

There are no requirements, or they are minimal, on required reserves, capital structure, liquidity of funds, compulsory deposit insurance, etc. Auditors' and local agencies' control is very moderate. Offshore banks are operated via management companies and other banks on special agreement basis.

Effective currency management. The use of an offshore bank as the currency management center of a corporate group will provide a flexible and fiscally effective means of controlling foreign exchange exposure. Group exchange gains or losses, whether realized or unrealized, can be consolidated into one entity with resultant cost and administration benefits. Overall foreign exchange risk can be reduced and hedging or borrowing costs minimized. Exchange gains, fees, discounts, and interest income can be treated on a group basis in the most tax effective way. Centralization of the currency management function allows more direct involvement by the group treasurer and the offshore environment permits him greater flexibility.

Enormous business opportunities

Eurobond issues and foreign currency loans are often raised through the medium of an offshore bank to maximize the overall tax effect by enabling the corporate group to disperse the funds as appropriate within the group. Free income from the group's confirming finance, discounts from debt factoring and interest derived from leasing or hire purchase transactions can be protected from the high tax rates applicable in the onshore jurisdictions. By conducting its banking ordinance activities through an offshore bank the corporate group will be able to carry out these operations essentially without interference from domestic regulatory authorities.

In general, the corporate group will aim to maximize interest deductions against profits in high-tax areas whilst protecting group interest income from tax by accumulation in an offshore environment. The offshore bank is therefore a most effective means of deploying accumulated group funds.

Choosing The Right Jurisdiction

The main in determining the location of an offshore bank are:

Taxation

In order to obtain the benefits previously outlined the offshore bank requires an operating environment which is tax free, has a low tax rate or provides concessional rates of tax to an offshore bank. Normally the former is preferred. The need for specific tax factors will vary with the requirements of the offshore bank. In some instances it may be desirable to utilize double tax treaties. However, in many circumstances they will be of no benefit and their exchange of information provisions may be detrimental to the activities of the offshore bank. An offshore banking center which does not impose interest withholding taxes will normally be preferred by clients of the offshore bank and will also be attractive to the offshore bank as interest withholding taxes are often part of its funding costs. The absence of a dividend withholding tax will also be an important consideration for the shareholders of the offshore bank. Taxes other than income taxes must also be considered. Stamp duty on loan or mortgage documents, receipt taxes and stamp duty on securities transfers can be significant cost factors where appropriate.

Capital registration fees and business or banking license fees should be kept to a minimum.

Legislation. All countries have legislation which regulates the carrying on of banking activities within their respective jurisdictions and in some cases also extends their authority to the external activities of domestic based banks. Locations which are suitable for offshore banking normally limit their primary regulations to control banking operations within the domestic sphere and provide a more relaxed set of banking rules for activities conducted with non-residents. Many offshore banking centers have a dual licensing system with full licenses for domestic banking operations and restricted licenses for offshore banks which conduct their banking activities with non-resident entities.

The banking legislation of a suitable offshore banking center should permit:

Low capitalization without statutory minimum capital and reserve requirements;

Loan raising without mandatory debt-equity ratios;

Unrestricted lending activities;

Complete foreign ownership of offshore banks;

Cash management without minimum liquidity rules;

Administration free from excessive reporting obligations;

Non-disclosure of client activities.

Obviously some of these advantages will not be required by all offshore banks, particularly those which are owned by international banking groups.

The corporate legislation or the offshore banking center is also an important factor and should complement the banking laws. Preferably the corporate law should be consistent with that adopted in jurisdictions in which the banking or corporate group operates. Special factors, such as anonymity of ownership, corporate secrecy provisions, transfer of corporate domicile and minimal reporting requirements may be attractive for some offshore banks.

Exchange controls

The flexible banking policies available under suitable offshore banking legislation will be severely restricted unless they are complemented by free movement of funds. The offshore bank must be able to move its funds freely through the international banking network and the offshore banking center should provide direct access to that network.

Other criteria

Various other factors should be considered in selecting a location suitable for offshore banking. These include:

Political and economic stability;

Availability of banking and professional expertise;

Access to telecommunications.

Operational Aspects

Banking activities

Subject to the terms of its license the offshore bank will be able to undertake any form of banking activity but the most common offshore banking operations include:

Deposit taking

Syndicated loans or Eurocurrency under writings

Corporate loan raising

Intra-group lending

Foreign currency management

Provision of confirming finance

Lease finance

Debt factoring

In other words, an offshore bank can carry out all usual banking operations of an ordinary onshore bank. However, in some jurisdictions an offshore banking license is issued on a special condition that the bank may accept deposits from only a limited circle of clients. Usually these are the bank's share-holders or persons mentioned in the bank's charter or license. Such a license is defined as "limited". In this case the bank may have a limited number of clients. Sometimes, an off-shore bank may begin its activities with "limited" operations and widen the spectrum of its services by acquiring a less regulated license in the future.

Foundation documents of an offshore bank usually provide for trust operations. The bank functions as a trustee and manages the clients' securities portfolios. Investment portfolios may include not only financial resources but also precious metals and other assets. Clients are serviced on a trust contract basis.

The following structures are often used: combinations of an offshore bank and an offshore investment fund, or offshore bank and an insurance company. Business activities of commercial banks are becoming more and more international and trust operations constitute a large part of these activities.

Formation

The procedures for incorporation of an offshore bank vary in each location. However, most of the more suitable jurisdictions the incorporation of an offshore bank is effected by the usual English law registration system. An application for a permit to incorporate must be lodged together with an application for an offshore bank or financial institution license. License applications must be accompanied by the information specified in the offshore bank guidelines. If the application satisfies the guidelines then a license will be issued promptly. Normally the application is a confidential document and may be subject to the secrecy provisions of the relevant corporate legislation.

Banks with a solid international standing get preferential treatment and certainly can obtain offshore banking licenses in any jurisdiction in the world. However, Eastern European banks for example, even the largest ones, could face some difficulties. It's much easier for them to obtain a limited offshore banking license. Not only large but medium or small sized banks, non-banking companies and even individuals are eligible for an offshore banking license in more liberal jurisdictions like Nauru and Vanuatu in the South Pacific. Usually recommendations from other banks, as well as lawyers and auditors are required to register an offshore bank. Proof of the applicants' solvency and, in some cases, business plan of proposed offshore bank is required.

An off-shore bank must have a registered office, minimum number of Directors and shareholders. A Registered Agent is a must in all offshore banking locations. Management and the accounting department are usually located in the place of the owners' domicile. In some offshore banking locations the management of the offshore bank must actually be located within the jurisdiction.

Management

Business activities of an off-shore bank are often conducted via its representations (registered or non-registered) around the world, through which business partners and clients can be contacted. The management and administration of the offshore bank should not be conducted in the domestic jurisdictions of the corporate group and care must be taken to ensure that offshore deposit-taking activities do not breach domestic banking laws. If too many of the management activities of the offshore bank are effected in the domestic locations the offshore bank may be deemed to be carrying on business there through a branch, with adverse consequences under both tax and banking legislation. The management functions should therefore be carried out by the offshore bank.

The offshore bank can either employ its own permanent staff and base them in the offshore location or in another suitable management location. Alternatively it can engage the services of a local trust company or professional management firm who would work closely with the management of the corporate group.

Most offshore banks choose the latter alternative which keeps management on an arm's length basis. It should also be remembered that the appointment of local management in the offshore location will avoid potential complications with tax and banking authorities in the domestic jurisdictions.