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Investment regulations for Offshore Banks

Also known as offshore banks, offshore banks are financial institutions that raise funds from the public, under the condition that none of their clients have residence in the country where the Bank is incorporated. In other words, their clients are foreigners in the country where the Bank has its place of business.

Offshore Banks vs. Onshore Banks

The Onshore Bank or traditional bankis a financial institution that can open accounts for persons domiciled in the territory where it has its place of business. As well as to foreigners legally residing in that country. 

It should be noted that there are countries whose legislation empowers banks to open accounts for foreigners. non-domiciled in the country. For example, in the case of Venezuela, the requirement for the opening of a bank account is the presentation of the Identity Card, whether it is a resident or a passer-by, therefore, in Venezuela the opening of accounts for non-resident foreigners is accepted.

What are the activities of an Offshore Bank?

An offshore bank is restricted as to the type of financial intermediation activities it engages in. to which it can dedicate itself. Traditional financial intermediation consists of capturing funds from the public, at an interest rate, to lend those same funds to third parties, at a higher interest rate, in order to obtain a profit.

Offshore banks may not engage in credit intermediation.In order to be able to pay interest to their depositors, the Offshore Banks invest the money of the savers in Securities quoted in the international capital markets. An example of this would be the Sovereign Bonds, or bonds issued by companies. The return on these investments must be sufficient to pay interest to its savers and earn a profit. 

Clients generally do not have access to the Bank's investment portfolio, which is usually confidential. However, an indication of the return obtained by the Bank on its investment portfolio is usually the interest it pays on its deposits. Thus we find that in those cases where an Offshore Bank remunerates its deposits with interest rates above market rates, it may be a symptom that its investment portfolio has a risk above the normal market risk.

Products offered by an Offshore Bank

The traditional products, on the liabilities side, are savings accounts, current accounts and Certificates of Deposit. On the asset side, being the case that Offshore Banks cannot grant credits, they have opted for an ambiguous figure of Credit Card guaranteed with Certificates of Deposit, in this way, it is understood that the Bank does not have credit risk, and, therefore, it is not performing a credit intermediation activity.

It is essential to clarify that offshore banks are not traditional banks with a teller window.Therefore, they cannot receive cash deposits at their offices, and are also restricted from making cash withdrawals at their offices. However, some legislations and exceptionally, allow this activity, but in a particular manner, so it cannot be stated that these banks have a box office activity, or the obligation to keep cash in their offices to meet the requirements of the public.

"Offshore banks cannot receive cash deposits or withdrawals at their offices."

The operation of an Offshore Bank

The Offshore Bank operates primarily through a correspondent relationship with another bank.. A correspondent account is an account that a Bank opens in another Bank, so that the latter executes the operations of receiving and sending funds on behalf of the Offshore Bank.

Offshore Banks hold a small portion of their portfolio in liquid resources in the correspondent Banks to meet the cash flow needs of its clients. To the extent that an Offshore Bank maintains several correspondent accounts, to the same extent it may diversify the payments requested by its clients among the most convenient option for the type of currency or the destination of the funds.

What are the investment regulations for Offshore Banks?

Due to the public service activity they perform, Offshore Banks must follow certain guidelines The objective of these guidelines is to protect depositors to prevent the Bank from incurring capital losses on their investments. The objective of these guidelines is none other than to protect depositors to prevent the Bank from incurring capital losses on their investments.

Limitations vary from country to country, but internationally the standard is that the regulatory and supervisory body of the Offshore Banks establishes that there are certain types of securities, according to its investment riskwhich cannot be in the Bank's portfolio. 

They also usually establish limitations to the percentage of the investment portfolio that may be exposed to a same issuer or country risk. In addition, they usually establish restrictions on investment in related companies or members of the same financial group to which the Bank belongs.

Offshore Bank supervision

These institutions usually have certain requirements for their opening and operation.The supervision of which is assigned to a public agency, generally under the Ministry of Finance. It is in charge of requesting the information it deems pertinent for the best performance of its functions, as well as receiving the periodic information that the Offshore Bank must report in accordance with the Law.

Traditional banking supervision differs from offshore banking supervision.The first deals with the quality of the loan portfolio, compliance with solvency, liquidity and capitalization ratios, among others. Offshore banks do not have capital requirements, nor credit portfolio requirements, since they do not carry out this activity. Their supervision is basically limited to their investment portfolio and compliance with the know your customer policy and prevention of money laundering, since their customers are not domiciled in the country, and therefore there is very little information that the authorities may have at any given time on such persons or companies.

In some countries the supervision of Offshore BanksThe supervision of the banking sector, due to its peculiar nature, is entrusted to different agencies than those that supervise traditional banks.

Deposit guarantee

The guarantee on bank deposits usually takes two formsIn some countries there is deposit insurance, where the Bank pays a premium so that its customers have the certainty that, in the event of insolvency, the insurance will partially cover the deposits. Other countries usually have a public scheme, regulated by the State, of a "bank deposit guarantee fund", which is nothing more than a body that receives contributions from the banks in the system, which become a guarantee in the event of the bankruptcy of any of its members. 

Worldwide, we can say that offshore banks are not part of any deposit protection system.whether private or public. Therefore, its clients assume the risk of the Bank's fate, i.e., its failure directly implies the total or partial loss of the deposits.

Client acquisition by Offshore Banks

Since offshore banks are not allowed to have customers from the country where they are located, they are not allowed to have customers from the country where they are located. In addition, the fact that they are incorporated, it is logical to think that they must offer some comparative advantage so that their clients will decide to entrust their savings to them.

The most common advantages are usually:

  1. Offer high remuneration for deposits.
  2. Tax benefits in the countries where they are incorporated.
  3. Strict confidentiality and bank secrecy policies. 

Considering that the Offshore Bank does not engage in fund-raising activity in the jurisdiction where it is incorporated, as well as, that it does not have a regular customer service, since its customers are not located in that country, it does not require a large sales or service staff in the country of incorporation, so its offices are usually small and mainly of an operational nature.

Sales activity is carried out on an international level in those countries where the Bank has a niche market.

About customer acquisition in Venezuela

Pursuant to Article 7 of the Banking Sector Institutions Law, article 7In order to engage in fund raising and intermediation activities in Venezuela, the banking institution in question must be authorized by the Superintendency of Banking Sector Institutions. 

Historically, offshore banks and banks from other countries have been raising funds in Venezuela.In addition, many of these institutions have lacked such authorization, using non-transparent mechanisms to attract clients and manage their funds and investments. This activity outside the Law, among other things, prevents recourse to the Venezuelan customer protection and defense agencies requesting their intervention in the event of any complaint or claim about the Bank in question.

Jurisdiction of incorporation

Refers to the country where the Offshore Bank is incorporated. and to whose laws and language the banking activity is subject. Traditionally, given that Offshore Banks carry out their deposit-taking activities outside their borders, depositors ignore or are unaware that, in the event of any conflict with the Bank, they must go to the jurisdiction where the Bank is incorporated, and the laws, or the agencies, of their country of residence do not apply in any way.

This clarification should be made because in order to attract customers, offshore banks have sales personnel in other jurisdictions.The Bank's resident personnel, who facilitate the process of opening and managing the accounts, creating the false impression that these personnel have any authority or competence. Any doubt or clarification should be resolved by the Bank's resident and competent personnel in the jurisdiction of incorporation, and in the official language of that country.

From the Financial Law Department At Alan Aldana & Abogados we have experience in advising clients on Offshore Banking matters.

The maintenance of a bank account in an Offshore Bank is an absolutely lawful act, however, we recommend that for the opening, maintenance and closing of such relationships, adequate advice should be obtained regarding the banking regulations applicable in the jurisdiction, the financial soundness of the Bank, the experience and accessibility of the Supervisory Body of the banking activity in such jurisdiction, and the tax and compliance implications of the regulations on Prevention of Money Laundering and Terrorist Financing.