Banking

Regulatory changes facing the offshore banking sector

Colin Powell, chairman of the Offshore Group of Banking Supervisors, examines the challenges facing offshore banking

In the past the international focus on the offshore banking sector arose largely from a concern on the part of home country supervisors, and those of the G7 countries in particular, that the regulatory standards being applied were not sufficiently robust.  This was considered to pose a threat to financial stability. This manifested itself in the Financial Stability Forum in 2000 when it received the report of a Working Group on Offshore Centres.

While that report concluded that such centres did not appear to have been a major causal factor in the creation of systemic financial problems, it was suggested that as national financial systems grew more interdependent future problems in offshore financial centres (OFCs) could have consequences for other financial centres.  As a result the Financial Stability Forum asked the IMF to initiate a programme of regular assessments of the OFCs to judge the extent to which they were in compliance with the international standards of financial regulation, anti-money laundering and combating the financing of terrorism.

All of the OFCs identified by the Financial Stability Forum have been assessed by the IMF and no evidence has been found that OFCs are a major causal factor in the creation of systemic financial problems or are material to global financial stability. The assessments of compliance with international standards also have shown that the results for OFCs and non-OFCs are similar, with good and some not so good performers in each group.

OFCs have responded to the concerns expressed by the Financial Stability Forum and other bodies and have recognised the importance of increased transparency for effective financial regulation, for AML/CFT, for the fight against corruption and for dealing with harmful tax practices but in every respect consider it is a global approach that is required. The distinction between OFCs and non-OFCs is no longer seen by the international standard setters as being important in addressing the issues of financial stability and transparency.

The emphasis has shifted to whether or not a jurisdiction is complying with the international standards, particularly those relating to transparency and information exchange. This has been reflected in the decision of the IMF in May 2008 to integrate their OFC assessment programme into their global financial sector assessment programme.

The timing of this change in approach was most appropriate because with the current global financial crisis it has become even clearer than before that in addressing the issues little if anything is to be gained by drawing a distinction between OFCs and other jurisdictions. In the first place it is difficult to get agreement on which jurisdictions are OFCs, because of difficulties of definition, and more importantly it is accepted that what is important for world-wide financial market stability is that all financial centres should be subject to the same international standards and should offer the same degree of transparency. The market disturbances which lay at the root of the current crisis did not originate in the OFCs but the OFCs share in recognising the need for global action if the difficulties now faced are to be resolved.

The OFCs are host supervisory authorities for the most part and accommodate subsidiaries and branches of international banks.  Their greatest challenge now and for the immediate future is how to deal with the problems arising from the impact of the credit crisis on parent banks. The OFCs are deposit gatherers and for the most part the subsidiaries and branches up-stream the deposits to the parent bank.  The strength of those subsidiaries and branches therefore rests on the strength of the parent bank, and the ability to recall funds if they are required.

In this context the OFCs have been greatly comforted by the steps taken by the governments responsible for the parent banks to ensure their survival, through recapitalisation and providing liquidity, particularly where the parent banks are considered to be of systemic importance.  In return those governments should be much comforted by the significant contribution that OFCs are making to the liquidity and profitability of the parent banks through the up-streaming of the deposits that the OFCs attract from customers all over the world.

One regulatory challenge faced by the OFCs arising from this situation, if there remains a concern for the position of the parent bank, is whether to place any limits on the up-streaming of deposits and whether there is any way in which a subsidiary in the OFC can be ring-fenced in the event of the collapse of the parent bank. This is a difficult call for the OFCs because while they face the regulatory challenge of how best to protect the interests of depositors, they are alive to the fact that a key reason why many banking offices have been established in their jurisdictions is to collect deposits for the benefit of the parent.

This regulatory challenge is obviously greater if the banking subsidiary in the OFC is part of a banking group that has a relatively high risk of failure than if the banking group is of such systemic importance that it is certain to receive government support in the home country and not be allowed to fail.

Notwithstanding the foregoing there will continue to be a tendency for some G7 countries to look for those to blame for the crisis and to see in the OFCs a problem to be dealt with.  In large part this is due to a continuing concern for what is perceived to be a lack of transparency, and the existence of barriers to international cooperation. 

The challenge to the OFCs therefore is to ensure that their regulatory standards are the international standards and that their reputation is not damaged by identification with financial crime. There is a reputational risk for both the financial institutions and the jurisdiction. In the regulation of their banks OFCs therefore will need to focus on their risk assessment procedures. This will call for quality staff who can be relied upon to understand the international standards and the importance of being in compliance.

Of key importance to OFCs is financial stability. As their economies are highly dependent on the provision of financial services cross-border, any instability in financial markets that significantly and adversely affects the demand for those services can have a major effect on the well being of their inhabitants. It is recognised that transparency is an important part of understanding markets and market influences and, while it has been accepted that the business activities of OFCs are not a causal factor of the significant financial problems experienced to date, the OFCs have an important part to play in providing for a necessary level of transparency.

For all financial centres the desirable characteristics of transparency can be listed as access, timeliness, relevance and quality.  The challenge for all is to achieve effective transparency.  For this it is necessary:

    * for quality information to be obtained and held by those practicing in the market place;
    * for the information that is obtained and held to be accessible in a timely manner for those   who need it for the effective operation and regulation of the financial market place;
    * for the information to be able to be shared between all relevant parties.

There has been a significant enhancement of transparency in recent years and OFCs accept that there will be an ongoing need to:

     * publish reports of assessments  of compliance with international standards carried out by the IMF;
    * supply data to international organisations such as the IMF and the Bank for International Settlements;
    * engage with international fora including the Basel Committee on Banking Supervision, FATF, IOSCO, IAIS, the Egmont Group, the Financial Stability Forum, the United Nations Counter-Terrorism Committee;
    * share information with other jurisdictions through memoranda of understanding between regulators, mutual legal assistance treaties, and tax information exchange agreements;
    * join in supervisory colleges in respect of major cross-border financial institutions (recognising that for many host supervisory authorities the subsidiaries and branches of foreign banks can have a systemic impact in their jurisdiction greater than the parent bank will have in its home jurisdiction);

The pursuit of effective transparency is not only important for the creation of the conditions that best secure future financial stability.  Transparency allied to international cooperation is also required to combat money laundering, terrorist financing and other financial crime including fiscal crime.  In addressing these issues OFC regulators face a number of challenges, in common with regulators generally, including:

    * participating in international efforts designed to create an international level playing field;
    * ensuring that legitimate confidentiality is preserved in line with international best practice;
    * ensuring that their financial service sectors remain competitive by achieving an acceptable balance between regulatory interference and being responsive to market needs;
    * ensuring that there is greater understanding by other authorities of how the information they require could be obtained (eg, who to ask and what procedure to follow);
    * improving the gateways particularly in response to the problems faced in exchanging information between different regulators (eg, between banking and securities regulators) and between regulators and enforcement agencies;
    * ensuring through both onsite and offsite supervision that regulated institutions comply with international standards of financial regulation and AML/CFT;
    * ensuring that they are adequately resourced to undertake the tasks involved both in terms of the number and quality of the regulatory staff employed;
    * ensuring that the regulatory resources available are used to best effect through the adoption of a risk based approach;
    * avoiding reputational damage through effective control over higher risk business, involving, for example, politically exposed persons and/or high risk jurisdictions.

What is clear from experience is that in meeting international standards of transparency, and participating in a global approach to necessary information exchange, OFCs can continue to be successful business centres.  As niche market operators they can play to their strengths in attracting legitimate business through being fleet of foot in responding to market challenges, and by building on their specific expertise.  At the same time by gaining international recognition of their effective commitment to and compliance with international standards of financial regulation and AML/CFT, the OFCs can ensure they are treated fairly and equally and are not the subject of discriminatory action on the part of the G7 countries.  Balancing successfully the demands of the market place and those of the international community is a challenge for the regulators as well as for those in the finance industry, but one that  the OFCs have shown they are more than capable of meeting.