UK: Setting Up an Offshore Licensed Bank

Who has never dreamt of being a private banker ? On such thin premises a whole market has erupted and some atolls had emerged as financial centre. This market received a boost with the possibility to market financial products via the Internet. This medium pushed the geographical irrelevance to the verge of breaking all banking regulations. Onshore countries were however quick to enact legislation that dealt with financial services through internet (see UK FSA rules).

Offshore licensed banking is now associated with money laundering issues and some noticeable scams. Some offshore licensed banks have collapsed leaving depositors few chances to recover their assets.

Against such a grim background is there a case to advocate for setting up an offshore bank. We believe so as long as the bank operates in a safe and sound manner and have proper internal audit and control infrastructure to support effective compliance with international laws and regulations.

Here we must issue a warning to our readers, this paper is dealing with offshore licensed banks. We are not studying cases of large banking networks operating a branch from an offshore jurisdiction such as UBS, Royal Bank of Scotland and the like. An offshore licensed bank is a company authorizes to perform banking activity purely outside of the jurisdiction where it has been granted its license.

Typically when setting up an offshore bank, one has the choice between 2 to three types of licenses, depending on the country and the Finance Act. The most sought would be a class A (or any similar denomination) license that enables banking activity in both offshore and onshore jurisdictions (subject to regulatory approval in the other jurisdictions). The second best would be a class B (or any similar denomination) that authorizes only banking activity outside the jurisdiction granting the license (which supposes that the bank is authorized in other jurisdictions). The third which is of limited importance is a license that permits banking activity within a designated group of persons and/or companies.

The class B license is the one widely marketed as for USD 35,000 anyone can virtually become a private banker ,from a tiny offshore jurisdiction. The license requires a minimum capital between USD 100,000 to USD 500,000 and the acts generally impose some restrictions as to persons (they must be fit and proper…) and the way business is conducted. However the absence of correct supervision has lead to some abuse. This article being directed to qualified persons we will concentrate on why there is a case to set up an offshore licensed bank when economics suggest that private banks have hit rough times.

Back in 2001 PriceWaterHouse Coopers issued a report where one could read that "the private banking industry was undergoing sweeping transformation and that this market was offering profit margins averaging 35% and a growth projected at 12 to 15% compounded annually over the next 5 years". The same year, Merill Lynch/Cap Gemini Ernst & Young in their World Wealth report stated that the market for private banking services continues to expand and that the value of the assets of HNW individuals was still growing. A year later, the Boston Consulting Group issued a more mixed picture as they showed that 6% of the wealth of the High Net Worth individuals has disappeared (USD 2.6 trillion were destroyed or the equivalent of the Switzerland’s market share) and that private banking profitability saw a drop of 69% in the USA and 34% in Europe with an average fall of 43%. Today’s market seems even grimmer though some banks have anticipated the drop; UBS saw its private banking costs drop by 1.5% last year (UBS annual account). Banks are cutting aggressively in their costs by layering people. At a recent wealth management conference , the bank consulting arm of UBS put forward the unthinkable (some years ago) proposition that some private bankers should redeem their license to transform into asset management firms. It remains to be seen if such offer will be followed up…

Let us offer an alternative : why not relocate private banking activity in an offshore jurisdiction where costs are lower. This is not a new proposition as much airlines and computer companies run offshore cost centre such as accounting, ticket administration…Of course, one would argue that an offshore situs is not appropriate for a private bank for lack of lustre. I would agree that the big banks have moved to offshore jurisdictions with a proven track of records such as Switzerland but not all banks can afford the cost associated with such move. Given the fact that not one bank controls more than 2.5% of the market of High Net Worth Individuals and that it is highly fragmented, it would make sense for a new entrant or a small banking network to operate from a low cost jurisdiction.

If, for clients, there is a case for geographical irrelevance, that is what banks make us believe during the past years to justify their internet strategy and cutting their branches, why it is not so for private banking!

Some would argue that the main component is the client/manager relationship and the confidentiality. Clients relationship can perfectly be managed onshore by regulated finance advisers. As to confidentiality I would leave the banks to face their own responsibilities. According to the testimony from Richard Small in 1999 to the Congress "during the course of examination by Federal Reserve examiners, all banks (emphasis added) provided the requested information".

A strong arguable point, due to the mortality rate of offshore banks, is the obligation for the bank to maintain adequate capital.. This I will concede as protection of clients’ assets is at stake. However Basel II understanding is relaxing such obligation and will enable banks, with good risk management system, to work with 20% less capital than currently required. The current Basel II papers are discussed amongst regulators and are facing opposition from small banks. An offshore bank with adequate capital and risk management would be in a better position than a small federal bank.

Therefore I think there is an economic relevance for small private banking network or new entrant into the market to relocate offshore. A sound business plan and infrastructure, a controlled development in onshore markets, a good risk management should ensure a development. I will also add as the cherry on the cake that the offshore bank could make substantial economy on the cost of regulation which amounts to an average 10% of total cost.