Question

Discuss what are offshore financial centres and its characteristics. Explain the advantages and the disadvantages of this banking system.

Allocation of Marks:

  7 marks discussion on offshore financial centres

  3 marks discussion on characteristics

  4 marks listing the advantages of financial centres

  7 marks discussion on advantages of offshore banking

  4 marks discussion on disadvantages of offshore banking

Answer 1

OFF SHORE FINANCIAL CENTRES

Offshore financial centres play a critical role in the international financial system. They provide finance, insurance, broking, holding-company and head-office services, and exist because the economic benefits outweigh their costs.

In a global economy, there will be bona fide business reasons for setting up a business in any country, including a low tax one. These dealings can be genuine and profits allocated to them commensurate with the economic value they add. Their role may include a wide range of business objectives.

For example:

i. They allow businesses to reduce costs and increase revenues through centralised group services within a multinational enterprise.

ii. They assist in the efficient and effective movement of capital and resources and provide opportunities for global investment.

iii. They provide facilities to manage financial affairs confidentially and ensure legal protection from unjustified claims through trusts.

CHARACTERSTICS OF OFF SHORE FINANCIAL CENTRES -

1.Low or 0% tax rate for non-residents: most often, non-residents are not subject to any level of taxation, unless for registration fees and maintenance expenses. This does not mean that residents do not pay taxes. They quite often pay high direct or indirect taxes.

2.Banking secrecy and secrecy established by law: in many countries, violation of banking secrecy protocol is punishable by a jail sentence.

3.Attractive commercial financial legislation: there are only a few requirements for funding admissions and company registration.

4.Flexible legal system: most of the offshore centers base their system on the common law, very favorable for business, for inheritance planning and registration of Trusts.

5.Political and economic stability: it is a crucial factor because when stability hits bankruptcy like what happened in Panama with the U.S. invasion in 1989, the money and business migrate to other places.

6.Good communication and telecommunications infrastructure: the contact with banker or investments manager can be established 24 hours a day through online banking, live chat or by phone. In general, a tax haven must have good infrastructure.

7.Multilingual assistance specialized in international finance.

These advantages typically include:

• Greater privacy.
• 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.

Advantages of Offshore Banking

• Offshore banks can sometimes provide access to politically and economically stable jurisdictions. This will be an advantage for residents in areas where there is a risk of political turmoil, who fear their assets may be frozen, seized or disappear.
• 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.
• Interest is generally paid by offshore banks without tax being 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.

Disadvantages of Offshore Banking

• Offshore bank accounts are sometimes less financially secure. In a banking crisis which swept the world in 2008, some savers lost funds that were not insured by the country in which they were deposited. Those who had deposited with the same banks onshore received all of their money back. Thus, banking offshore is historically riskier than banking onshore.
• Offshore banking has been associated in the past 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. However, offshore banking is a legitimate financial exercise undertaken by many expatriate and international workers.
• Offshore jurisdictions are often remote, and therefore costly to visit, so physical access and access to information can be difficult.