Endangered species: the offshore bank

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From the Isle of Man and Gibraltar to the Cayman Islands and Barbados, international banks have been terminating their correspondent banking relationships and quietly closing their doors. International Investment’s Paul Golden explores what the offshore jurisdictions are doing to protect, and in some cases rebuild, their domestic banking infrastructures.

Retail banking is a long way removed from the rarefied world of secret offshore accounts and complex financial structures. Nevertheless, it has suffered significant collateral damage from actions taken against tax havens – not just since the news of the 11.5 million leaked “Panama Papers” documents broke in early April, but beginning around 2008 with the global financial crisis and “credit crunch”.

Retail banking operations in offshore centres have also been hit hard by a series of highly-publicised cases over the past seven or eight years, in which banking industry whistleblowers went public with what appeared to be large-scale, systematic tax evasion by certain high-net-worth individuals, sparking massive fraud investigations by the IRS and other tax authorities that in turn often led to massive fines.

Most recently, historically low and even negative interest rates have hit banking’s profitability, forcing multi-national institutions to let go of their least profitable operations.

Among the most recent bank pull-outs have been BNP Paribas’s closure of its last two operations in the Cayman Islands, unveiled last month. In April, Barclays announced it was to close its last Gibraltar office, two years after it began winding down its retail banking operations there.

In January, meanwhile, the Isle of Man’s financial regulator announced a consultation, as it considered whether to introduce a new banking model, in an effort to address what it noted had been a recent decline in the island’s traditional offshore banking sector.

This came just weeks after Guernsey’s treasury minister, Gavin St Pier, detailed plans to encourage the creation of a new “savings and loans’-type institution” on that island.

‘Correspondent banking’

To best understand the situation in such offshore jurisdictions as the UK’s overseas territories and Crown Dependencies, it’s helpful to understand the “correspondent banking” system, which is the basis for banking services in many of these places. This is the mechanism that allows small banks in such communities to contract with larger institutions, in order to provide their customers with the types of necessary services that no small bank could provide on its own.

In other words, the correspondent banking system enables national banks in small jurisdictions to access the global financial system, and is crucial to the functioning of the banking system in many parts of the world.

But what has been happening recently, according to banking industry sources, is that international banks have been retreating from these arrangements out of concern that if they don’t, they risk unwittingly invoking the ire of increasingly-watchful regulators, or of being forced to pay out huge compliance fines stemming from the activities either of their clients or of correspondent banks abroad.

A survey of clearing banks published by the British Bankers’ Association in 2014 found that thousands of correspondent banking relationships have been shut down since 2011. The average bank had seen a 7.5% fall in the number of relationships it maintained, and two of the 17 banks surveyed had terminated one in five of their relationships.

Sir Ronald Sanders is an Antiguan diplomat who has long been active in, and outspoken about, Caribbean political issues. One of his contentions is that the Caribbean region continues to be designated a “high risk” area for financial services by “the powerful nations” of the OECD, even though the Caribbean countries have agreed to implement the US Foreign Account Tax Compliance Act (FATCA), signed tax information exchange agreements with the majority of countries in North America and the EU, and implemented all the rules of the FATF and the OECD’s global forum on transparency and exchange of information for tax purposes.

The result of this “high risk” designation, according to Sanders, is that many US banks regard the risk of exposure to significant penalties for even unintended infractions to outweigh the revenue they potentially generate from their correspondent relationships with Caribbean banks.

Local and indigenous replacements

Francoise Hendy, special adviser and lead treaty negotiator for the Barbados High Commission, admits that the withdrawal of correspondent banking services has significant implications for any jurisdiction that, like Barbados, has a currency that’s pegged to the US dollar.

But she says that in Barbados, the withdrawal of overseas banks has been followed by the emergence of local or indigenous institutions.

In 2012, for example, First Citizens (Barbados) Bank acquired Bermuda-based Butterfield Bank (Barbados).

“We also have a strong credit union culture, so people are accustomed to accessing banking services, such as mortgages, from institutions other than banks,” adds Hendy.

Timothy Ridley, who has practised as a Cayman Islands attorney-at-law for over 30 years and is a former chairman of the Cayman Islands Monetary Authority, says domestic retail banking in Cayman has not been significantly affected by rationalisation, but that correspondent banking is another matter. That’s because most retail transactions in Cayman are denominated in US dollars, and thus have to be cleared ultimately through a bank that is a member of the Federal Reserve.

“Due to increasing burdens of regulation and compliance and reputational risk concerns, major banks in New York have been reviewing the risk-reward of acting as correspondents to foreign banks worldwide, and not just in the Caribbean,” says Ridley.

“This has led to cancelation of correspondent relationships in a limited number of cases, and also an increase in fees charged.”

He suggests that some central banks may respond by establishing Federal Reserve-licensed operations in New York, which are then able to serve as the correspondent and clearing bank for the banks in their jurisdictions.

New players sought

Thousands of miles to the north and east of sunny Cayman, meanwhile, the Isle of Man’s re-jigged banking regime is taking shape, according to Simon Pickering, head of retail financial services at the Isle of Man Department of Economic Development.

Pickering describes the new alternative banking regime, which is aimed at attracting more banks to the island, as the culmination of more than 18 months planning and consultation between the Department of Economic Development and the Financial Supervision Authority, the island’s financial regulator.

“Banking underpins all business sectors, so the regime has been designed to [encourage] new players to consider an Isle of Man branch or representative office,” he explains.

The main change sees the existing Class 1 retail deposit licence replaced by three categories of licence:

• Class 1(1) – Non-restricted (including retail) deposit takers that provide services to the full spectrum of customers;

• Class 1(2) – Restricted (including non-retail) deposit takers who only provide services to corporates and HNWIs; and

• Class 1(3) – Representative offices of foreign banks created for marketing and business development purposes, but which must not undertake any transactions.

One side effect of the post-global financial crisis “crackdown” on “tax havens” and tax evasion, some in the industry say, is that it has begun to make just having a presence in certain jurisdictions seem suspect, even when these jurisdictions have gone to significant lengths to meet every conceivable regulatory requirement.

Bob Lyddon, general secretary of the International Banking Association (IBOS), says banking services provision in many markets is in a state of flux, and refers to the positioning statement of one UK bank that conflates “overseas” and “speculation” as indicative of what is currently politically acceptable for British institutions to be involved in.

“Offices in Geneva, Monaco, Grand Cayman or Isle of Man are embarrassing just to have, let alone if they do business,” says Lyddon.

“UK banks have suffered large and well-publicised fines for anti-money laundering, and countering financing of terrorism legislation breaches, and [are now contending] to regulators that their houses are in order. [But] how can they [the regulators] be so sure, if they [the banks] have so much as a nameplate in an offshore banking location?”

According to Lyddon, these operations will often be chopped – not because there is no demand for the services, or because no money can be made – but because of reputation and financial risks to the group.

“One should assume that this will be the attitude of at least all banks outside the US that have a US banking licence – in other words, all the big banks in the OECD,” he says.

“The slack will need to be taken up by expanding non-OECD banks, local banks or sub-regional banks, but any banks stepping into the opening left by the withdrawal of the big boys will have trouble getting the correspondent accounts these institutions provide in their home country.

“The more the new kids on the block get into offshore banking and the greater the volumes they capture, the more likely it is that the correspondents will shun them.”

The outlook

In Lyddon’s opinion, we’ll probably see the larger banks continuing to concentrate on supplying banking services in countries with large GDPs in goods and services.

As for the jurisdictions themselves, those that have focused on private client/HNWIs, particularly non-resident clients, other experts say, may suffer more, at least for the foreseeable future, than those with a broader base of local retail and corporate banking business, as FATCA-type laws are introduced by major countries concerned about tax avoidance and evasion.

   Gibraltar’s solution: DIY

Small island jurisdictions and UK territories that are considering what to do in the wake of the departure of their major banking institutions might do worse than to pay a visit to Gibraltar.

The government of the British overseas territory, located on the southernmost tip of Spain, decided some years ago to act when one of the two major international banks then servicing its 29,300 residents announced plans to close its remaining operations.

Barclays first started offering banking services in Gibraltar in the late 19th century, so its 2014 decision to wind down, as part of a new corporate strategy to exit all “non-core businesses” internationally, was greeted with shock on The Rock. (Gib’s other major retail bank, Natwest, is a relative Johnny-come-lately, having opened for business about 100 years later).

Barclays’ decision to introduce a “fly in” service, operated remotely from London, was criticised by Unite, the bank workers’ union, with its national officer for finance, Dominic Hook, saying the departure of full branch banking services would leave local residents and businesses “high and dry”.

James Tipping, the Gibraltar government’s finance centre director, says the prospect of having just one bank in the market made the Government realise the necessity of developing a state-owned institution.

Thus an application was duly filed with Gibraltar’s Financial Services Commission in December 2013 and, after a couple of years of wrangling, the Gibraltar International Bank finally opened its doors last June. A second branch opened in April.

Separately, the Gibraltar government approached a number of challenger banks based in the UK and elsewhere, according to Tipping, and although thus far none have announced plans to enter the Gibraltar market, he believes one or more might at some point, given, among other attractions, the fact that the territory shares a language, currency, common law-based institutions and other characteristics that would make it a natural fit with an organisation already doing business in the UK.

“However, that was always plan B – plan A was Gibraltar International Bank,” he adds. “We hope that smaller institutions will realise that there is a profitable niche in the market here, but we are much more relaxed about that, now that we have a dedicated retail bank that is here to stay.”

Tipping – who says a number of other jurisdictions have asked Gibraltar about its experience of creating a state-owned retail bank – accepts that Gibraltar International Bank may not have come to pass had Barclays not decided to pull back from the British overseas territory.

“However, it addresses any concerns over what happens in the event of a retail bank pulling out of Gibraltar.”






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