What is offshore banking?

Refers to saving your money in an account in a foreign location, generally due to lax tax laws in the region. Has gained significant popularity with offshore banks amassing over 25% of the world’s wealth.
Offshore banking refers to a person storing his savings in a bank account located outside his country of residence, typically in a location that is considered a tax haven in order to be able to claim legal as well as financial advantages.

A Brief History

The term ‘offshore banking’ originated in the United Kingdom and referred to accounts in banks located in the Channel Islands. Since the Channel Islands were located in the English Channel, the term gained popularity and now applies to all banks outside the resident’s country.

Offshore banking is generally preferred by individuals and companies residing in a country where taxes are exceptionally high. Hence, they prefer siphoning off money to banks where either the tax rates are low or the tax laws are incredibly lax.

On the other hand, it is also utilized by organized crimes to hide money that has been obtained illegally, which is why offshore banking has a negative stigma associated with it.

Of course, as is true with any controversial venture, there are benefits as well as disadvantages which have traditionally been associated with offshore banking.

Advantages of offshore banking

  • Many people prefer offshore banks because they tend to provide stability while their own country faces political turmoil, which greatly increases the risk of their assets being stolen, frozen or even seized by the government or even hostile forces.  Hence, it is not unusual for people in countries in the midst of political pressure to move all their liquid assets to offshore banks.
  • Another advantage that may be experienced by people investing in offshore banking is the fact that offshore banks may provide a higher interest rate due to a lower risk of government intervention as well as low overheads. However, this belief may not hold true in the current situation as studies have shown that most offshore banks offer similar interest rates as compared to those offered by local banks.
  • Offshore banking provides economic growth for regions which are geographically remote.  This can lead to an encouraging transfer of wealth from developed countries to developing countries, leading to growth in such countries.
  • Since offshore banks do not deduct tax on the interest accruing on their accounts, individuals who do not have to pay tax on worldwide incomes have an added benefit of investing in such banks.  Furthermore, individuals who believe they can evade tax by not disclosing their income may also be encouraged to invest in offshore banks.
  • Individuals may be enticed to invest in offshore banks simply due to the fact that such banks often offer a range of services that are not provided by local banks. These may include various investment options, high or low rates of interest on loans depending on the risk and anonymous bank accounts amongst various others.
  • Proponents of offshore banking have often claimed that this practice increases competition in the banking and tax industry, thus allowing customers to choose the option that is the most alluring to them.

Disadvantages of offshore banking

The aforementioned points do not encompass all the benefits that are available for those who pursue or choose offshore banking. In fact, they just serve to show some of the myriad of benefits available. However, there are always two sides to a story. There are also some disadvantages linked with offshore banking, which include the following:

  • It is true that offshore banks are sometimes not as financially secure as onshore banks. This was proven true during the 2008 banking crisis which saw many people lose their savings invested in offshore banks.  In fact, according to estimates, only 40% of people had their funds refunded by offshore banks. Meanwhile, onshore banks refunded their clients in full after the crisis, thus showing the vulnerability of offshore banks.
  • As mentioned earlier, offshore banks have often been associated with money laundering, underground economy and organized crime. In fact, many offshore banks have been accused at various times of supporting illegal or even terrorist activities due to their lax regulations.
  • Furthermore, often, offshore banks are located in areas which are difficult to access physically. However, due to the advent of online banking, this problem has been significantly reduced.
  • Often, individuals and companies with a high level of income have the resources to be able establish accounts in offshore banks in order to reduce their tax liability. Hence, the burden of tax in the home country often has to be shouldered by the middle and lower income groups causing a disproportionate spread of wealth in the country, which in turn negatively affects the economy of the country.

Scope and extent of offshore banking

Offshore banking has become integral to the international financial system, with experts claiming that nearly half of the world’s capital resides in or at least travels through offshore banks. This can be seen by the fact that nearly $13-20 trillion dollars are stored in offshore accounts. Furthermore, just to get an idea of how immense offshore banks are, tax havens host nearly 1.2% of the world’s population while storing nearly 26% of the world’s wealth!

In fact, estimates claim that if such offshore banks were susceptible to tax (making the assumption that no money in these accounts is liable to tax), revenue of over $100 billion could be raised in taxes.

Offshore banking regulations

Regulation of offshore banks is generally supervised by international bodies such as the International Monetary Fund. While regulations used to be extremely casual up until the start of the 21st century, the 9/11 attacks brought an end to that. Of course, there are still many critics who believe that the regulations are not sufficient to prevent illegal activities. Furthermore, with most countries making stringent laws regarding money laundering, banks are now starting to disclose information that they believe is relevant to money laundering cases.

Conclusion

The world is divided on the issue whether offshore banking is legitimate or not. As pointed out throughout the article, there are benefits as well as drawbacks in this decision. Hence, it would be appropriate to deliberate the pros as well as the cons before coming to an informed decision in this regard.

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