The Hindu Business Line : Offshore banking: A lucrative proposition

Financial experts have been pleading to establish an offshore banking centre in India. Geographically, India provides distinct advantages in attracting offshore banking units, because it has a stable economic and political performance, a vast market, technical manpower that could find employment in these centres. The question is: Will these offshore banking units fulfil Mr Murasoli Maran's cherished goals?

ONE of the significant features of the Exim Policy is the proposal to permit offshore banking units (or overseas banking units) in Special Economic Zones (SEZs). Offshore banking refers to the international banking business involving non-resident foreign currency-denominated assets and liabilities. It refers to the banking operations that cover only non-residents, and does not include domestic banking. An offshore banking centre is a place where deliberate attempt is made to attract international banking by offering many concessions in the form of taxes and levies imposed at lower rates.

A more important relaxation is the exemption of the offshore banks from restrictions on operations. Offshore banking units in these centres can carry on their activities with international enterprises or investors without conflicting with the domestic fiscal and monetary policy.

Offshore banking centres offer the following benefits:

Exemption from minimum reserve requirements.

Freedom from control on interest rates.

Low or non-existent taxes and levies.

Entry is relatively easy, especially for large international banks, in contrast to the situation in neighbouring countries that may strictly limit or prohibit the entry of foreign banks.

Licence fees are generally low.

Close proximity to the important loan outlets or deposit sources; for instance, Bahrain is an offshore base for petro-dollars.

Offshore banking is an extension of the euro-currency concept to the East, which provides a link between euro-currency markets and the final borrowers. They provide essential time zone links that are truly world-wide, and ensure that the market operates 24 hours a day. While offshore banking is an integral part of the euro-market, what distinguishes it from the mainstream euro market is that it was specially set up by host countries to promote international banking.

Offshore banking units are branches of international banks or other subsidiaries or affiliates. They do not carry retail business, but generally provide wholesale banking services — project financing, syndicated loans, issue of short-term and medium term instruments, such as negotiable certificates of deposits and capital notes — as well as merchant banking activities in foreign currency denominated bonds and equity shares.

The deals are mostly between banks or with large borrowers or multinational corporations. MNCs prefer transacting in offshore financial centres because of certain apparent advantages: Avoidance of high tax incidence; freedom from exchange control; maintenance of secrecy of deals due to non-interference from government and regulatory authorities; and deferring tax by floating subsidiary units in such centres and delaying their remittance of profits to the parent company, when it would be taxed.

Participation of the Indian banks

Few Indian banks, such as State Bank of India, Indian Overseas Bank, Bank of India and Bank of Baroda, have set up offshore banking units for deposit taking and final lending at Bahrain, Hong Kong, Colombo, Cayman Islands, and so on. Indian Bank, Bank of Baroda and Union Bank of India jointly floated a deposit taking company, IBU International Finance, in Hong Kong for both offshore and onshore banking.

The benefits for the Indian banks from these ventures are:

Sizeable profits — as these ventures involve relatively low operating costs.

With multi-currency deposit bases, the banks would be able to serve better the needs of their customers who have set up joint ventures abroad in the form of foreign currency finance.

The banks would strengthen the country's balance of payments through repatriation of profits from the venture.

Offshore banking centre in India

Financial experts have been pleading to establish an offshore banking centre in India. Geographically, India provides distinct advantages in attracting offshore banking units, because it has a stable economic and political performance, a vast market, technical manpower that could find employment in these centres. Another advantage is that the Indian market would open a little before the Tokyo market closes, and close before New York opens, thus providing a vital time link for international money market dealers.

In an era where many Indian corporations are functioning abroad, and many corporations are granted permission to seek overseas finance, establishing an offshore unit will help tap the resources:

Exporters would benefit in terms of finer margins on loans and better foreign exchange rates available via an offshore banking unit.

The benefits of multi-currency operations which, to an extent, minimise currency fluctuation risk, will be an added advantage.

Salaries paid by offshore banks and local expenditure incurred by them contribute to the economy's welfare. For smaller countries, the benefit would be greater. For a larger country such as India, however, this may not form a significant portion of the total income.

India may earn revenue in the form of licence fees, profit taxes imposed on the banks operating in the area. It may also get the benefit of banks' funds in the form of capital and liquidity requirements.

The country can gain improved access to the international capital markets.

The domestic financial system may become more efficient through increased competition and exposure of the domestic banks to the practices of offshore banks.

The offshore banking centres will provide opportunities to train the local staff which will, in turn, contribute to faster economic growth.

The offshore banking units would help channelise non-resident Indian investments.

Setting up offshore banking centres would trigger enforced development of more advanced communication facilities — a must for their functioning.

But establishing offshore centres also comes with a price:

The supervision and regulation of offshore banks may involve substantial costs.

Encouraging offshore banking may result in the diminution in autonomy of domestic monetary policy, since it is difficult to draw a line always between the offshore and onshore operations, particularly in the absence of exchange control.

Offshore banking provides scope for tax evasion by residents. For instance, in Hong Kong, it was found that residents place deposits with offshore banks and take loans of the same amount. The interest on loan would be a deductible expenditure for taxation, while the income from interest on deposits is not taxed.

Offshore banks may prove to be harmful competitors to the local banks and may inhibit their growth.

For long, Mumbai was considered suitable for establishing offshore banking here. The city has all the requirements — goods infrastructure in the form of telecommunications and services, abundant and well-trained manpower and presence of many international banks, both Indian and foreign, already engaged in international banking.

The Sodhani Committee on Foreign Exchange Reforms (1996) has recommended allowing Indian banks and financial As against the general recommendation of permitting offshore banking units only at Mumbai, the present proposal is to permit them at Special Economic Zones. This is a wise move since both offshore banking centres and SEZs have many things in common as regards administration and purpose. The establishment of offshore centres in India was foreseen when the Foreign Exchange Regulation Act (FERA) was replaced by the Foreign Exchange Management Act, 1999 (FEMA). Article 10 of FEMA included offshore banking units as one of the authorities to whom the RBI could delegate powers for dealing in foreign exchange. The question is: Will these offshore banking units fulfil Mr Maran's cherished goals? The RBI is expected to bring out regulations regarding setting up these units in India. A lot depends on how far these regulations are liberal and pragmatic.

(The author is Associate Professor in International Finance at the PSG Institute of Management, Coimbatore.)

Send this article to Friends by E-Mail

Stories in this Section
a la carte versus buffet

Economic and fiscal policy reforms -- I: Looking back to move ahead

Accounting avalanche

The divide(n)d turf

Rescue mission

The slick on the oil front

Of sweepers, litterbugs and government corridors

Industry bodies must reinvent themselves

Offshore banking: A lucrative proposition

Few benefits for construction workers

Home is not best?