Why offshore banking? Why in the year 2000? What's your prediction: is offshore industry taking off or is it going to crash and render our efforts useless? How will the technological revolution in computers, data processing and the telecommunications affect off-shore banking? What rules will off-shore companies of the future play by?
This presentation explores several points of view on these exciting issues.
My argument is based on an assertion that the information revolution is revitalising all of the major conditions, shaping the world of off-shore banking, and leading to brand new rules for the game called "off-shore banking". In what way? We'll answer this question by analysing the transfiguration of new business conditions in offshore business, the new positioning of off-shore banking industry, and the influence of the artificial intellect decision-making process.
Let us first consider the positioning of the offshore banking industry as an area of intersection between the banking and the offshore business.
Offshore trade, holding, and investment companies have obvious advantages and disadvantages in respect to domestic companies. However, offshore banks, when compared with other banks, don't, at first glance, look like the best option for companies.
What type of perspective are offshore banks faced with? Will only small, in-house offshore banks survive, or will they compete with other banks?
To respond to this question, we need to analyse major environmental business conditions and competitive forces in the banking industry and how the information revolution is changing them.
2. ENVIRONMENTAL CONDITIONS AND TRENDS
The estimated time between starting an operation in a region and achieving full scale success is measured by months, if not years, due to the natural speed of the educational process and reorganisation.
The impact of using the Internet as a service delivery tool and dramatic reduction of data processing costs enable small banks to provide services globally.
Small domestic banks can hardly utilise this advantage due to a generic orientation on the domestic market and the confinement of legal restrictions. Conversely, offshore banks developing in a multinational environment don't face these limitations.
3. DISTINCTIVE COMPETENCE
For clarifying the transformation in offshore banking competence, let us point out the following key factors:
- amount of funds available
- access to the market
- variety of products
- fund wearing ability
- speed of processing
- level of quantitativity in measurement
Except for the last one, these characteristics are presently not favourable for offshore banks.
Because of the profit-oriented nature of offshore business, offshore banks have a good reason to utilise high quality quantitative methods provided by computerised accounting. Other banks are concerned with tax incentives as well, thus precision in measurement and reflection of real profitability may not be the priority for a heavily taxable organisation.
In addition to above-mentioned changes, new information technology furnishes offshore banks with powerful tools for speeding up data processing, simplifying access to the world wide market and providing an opportunity to manage overseas through Intranet and other networking methods. These features reduce the inherent disadvantages of offshore banks vs. onshore ones.
Fund wearing ability depends on both communications equipment and a correspondent banking net. Due to restrictions imposed on offshore banks the last factor can exert drastic influence on the substance of fund wearing.
4 CORPORATE RESOURCES, PRODUCTS AND MARKETS
An essential part of the decision making process when positioning the industry is analysis of the following factors that define corporate resources:
- access to a money market
- equity investment
- debt investment
- deposits
- borrowing facilities
The current situation is generally more favourable for onshore banks than for offshore ones. Availability of all types of financial sources is distinctly in favour of onshore banks and other onshore entities. But will this be the case in a few years?! Later on we'll present some arguments in favour of improving the situation for offshore banks through technological innovation.
Product substitution and market development, including a market leaders policy, has to be taken into consideration when analysing the transition of offshore banking industry.
So, several main banks will be dominating the market with a number of service-oriented banks working to some extent as a part of the service delivery system.
5. ANALYSIS OF COMPETITIVE FORCES
5.1. Key Points
Are there any signals, indicating that a technological change in the banking industry could change competitive forces and, as a matter of fact, change the structural determination of offshore banks? We'll all apply the expectations presented above for analysing the transition of competitive forces that shape the offshore banking industry.
The essential point to be discussed is: "Will the technological change in offshore banking industry trigger changes in both banking and offshore industries?" If we arrive at an affirmative conclusion "yes", it is important to determine the direction of this change and to clarify the methods to derive benefit from the present trend.
5.2. Threat Of Entry
High barriers to entry into the banking industry are perfect signs that it is a mature, well established industry. All major sources of barriers to entry, such as:
- economies of scale (decline of product or services operational costs with increase of volume and operational time)
- product differentiation (measured by brand differentiation and evidence of customer loyalty)
- capital requirements (high level of start up costs, measured by dozens of affirmative millions of USD)
- cost advantages or switching costs (the cost facing buyers for switching from one supplier to another)
- access to distribution channels
- government policy
Look like a great wall protecting already established onshore banks against new entrances. But appearances are deceiving. Information revolution is leading to the most dramatic change in height of entry barriers - almost all of them can be overcome by well computerised small banks, as easily as one can get over the greatest of walls by using a helicopter. Well established, mature banking industry ought to expect many new entrants, and thus a sizeable increase in competition. Offshore banks will probably comprise the majority of new entrants.
5.3. Power Of Suppliers And Buyers
As a group of firm producing substitutable services, onshore and offshore banks must be viewed as if in the same industry, but the current situation with regards to positioning of suppliers and buyers is completely different. For domestic market banks (suppliers) mostly have marked superiority over clients(buyers). Big banks, supplying services and capital for other banks enjoy superiority also. The situation becomes even more obvious if we include offshore companies in the group of bank services buyers. Offshore companies often have problems opening a banking account and normally do not have access to sources of capital through direct borrowing or the stock exchange. Offshore banks as buyers from other banks experience similar problems. The whole system of supply is structured as a perfect hierarchy.
In the offshore industry the situation looks quite different. As service suppliers, offshore banks have roughly the same power as their customers, mainly offshore trade companies, and thus have to maintain higher flexibility and sensitivity to customer needs. On the other hand, availability of offshore banking services increases the offshore companies' power.
As a result of the Internet, availability of banking services is growing rapidly and is reducing, as a general rule, the power of suppliers. Thus, the banking industry is moving into the direction of equalising the position of suppliers and buyers, or, in other words the industry is moving in the direction which already exists in the offshore industry.
Such a trend is increasing competition among banks, and reducing profit expectations. According to above mentioned-reasoning, offshore banks do not loose too much as suppliers and can benefit from the situation as buyers.
5.4. Substitution Of Product
Let's assume that banks supply roughly four major types of products - money transaction services (in different forms), deposit taking (investment activity support), money lending and documentary services.
Due to the nature of banking service and as a result of using computers, all services become increasingly standardised. The availability of services due to development of telecommunication technology and the Internet is decreasingly dependent on the geographical location of customers. The important implication, making the reason for substitution of banking products clearer, is local restrictions that impose limitations on domestic companies' use of services provided by foreign banks. Such restrictions do not apply to offshore companies. The obvious conclusion can be derived from this argument: in offshore industry, substitution for banking products and consequently competition is much more intensive then in onshore business.
From this point of view, the restriction on banking services for offshore companies looks like a collective reaction to protect the banking sector against an increase in substitution of products and therefore against increase in competition. In this case, the move of offshore banks towards the segment of banking services for offshore companies appears as an attempt to fill a niche in the market.
5.5. Competition
For analysing competition facing offshore banks we'll take into consideration that from two types of generic competitive strategies: overall cost leadership and differentiation and focusing, offshore banks generally implement the third one. Offshore banks are mainly focusing on a particular buyer group or geographic area. The development of "the Internet society" is changing this situation by diminishing the relevance of geographic locale on one hand and by providing world wide services through the Internet on the other. Low cost world wide services offered by offshore banks create a completely new level of competition in this segment. An opportunity to advertise and offer special services through the Internet provides for new incomes broadcasting and advertising opportunities with a low cost and high efficiency inherent in "mouth-to-mouth" information distribution.
Development of new banking software is to be expected in software oriented groups. Taking into account the dramatic cost reductions in data processing, led to by new technologies, it makes sense to expect a high level of competition in all sectors of the banking industry. A new segmentation of the existing market as well as an establishment of new market segments such as E-money, on-line banking, the smart card, Internet investment services, and so forth, is extremely likely.
Offshore banks have a good chance to compete in this environment in all segments of the market.
5.6. Threat Of Exit
With competitive forces stimulating competition, unsuccessful competitors want to leave the industry. But their actual behaviour is determined by exit barriers. How will the information revolution affect the situation? Could unsuccessful players leave the banking sector without big financial loss, or will they stay and fight? Are there any special characteristics attributable to offshore banks?
The current banking industry requires high levels of investment in data processing, special office equipment, etc. Consequently, we can assume that exit barriers in the banking industry are relatively high. Keep in mind that these barriers position the present risk of entry into the banking industry at a high level and keeps entrepreneurs away from the business.
What is the position of offshore banks that enter the industry with a high-tech approach? The price reduction in computer technology and low cost of telecommunications, provided for by cheap access to the market through the Internet, will mean, in the nearest future, sustainable competitive advantage to banks linked with software companies. Why? Software becomes the dominating part of cost of entry, and ability to develop data processing technology can be the main source of competitive advantage. On the other hand, fast technological development makes previous investment obsolete almost, instantaneously. So medium-sized banks lose competitive advantage to the small banks, because they can't afford the perfection and the cost of capital of big banks, thus they are less flexible than the small ones.
The opportunity for new entry for small players exists in the industry as a whole, but offshore banks have less restrictions in this area and are viewing it as a high-risk venture from the get-go. This means that, compared to domestic banks, offshore banks would be more willing to shoulder the risk of high exit, and may create some form of economies of scale and thus reduce this risk.
5.7. Profitability Expectation
Taking the general trend into consideration, it is reasonable to expect a sufficient drop in profitability of banking businesses. This trend would cause an acceleration of technological change and new market segmentation. The Internet is a completely new tool for service delivery which equalises offshore and onshore banks or, more precisely, diminishes the border between these two sectors of the industry.
We assume the industrial trend will be similar to that in the computer industry 5 - 10 years ago. During that time frame in the computer industry:
- the competition increased
- the leadership structure changed completely
- leader companies achieved greater profitability
- the average profitability in the industry dropped to zero
6. CHANGING THE RULES OF THE GAME
6.1. Offshore Banking In A Borderless World And Internet Society
The analysis of competitive forces in the banking industry clarifies the fundamental change in the rules of the game caused by new technologies. The position of offshore banks in the industry as a whole is changing as well. What options are there in the upcoming period of industry instability; how can the competitive move of offshore banks be performed; how can escalation of industry competition to a battle be avoided?
Offshore banks obtain an opportunity to move from small focused organisations to global players. To describe the new situation laconically and to create a defensive strategy for the offshore banks during the transition period let's evaluate the new situation:
- Offshore banks will become "insiders" on local markets through the Internet and other telecommunications equipment.
- Sustainable growth for Internet Banks and E-money generally will lead to a new market. Segmentation in the banking industry with new products and services, along with strong competition is likely to escalate industry instability (it's important to point out that a situation such as this is a result of technological revolution and is not linked directly with the offshore banking sector).
- "Global citizens and companies" can achieve global services and face ambiguities with "local" taxes (for example: how do you determine the tax collecting authorities for Internet merchants - by store location, by server location, by customer's location, etc.)?
- New allies and rivals in the industry are to be expected due to the crucial role of the high-tech component in competitiveness of the banks.
6.2. New Rules
It's hard to predict the behaviour of all major players and their reaction to new business conditions. But as a group of new players, offshore banks could create a co-operative strategy to prevent warfare. A co-ordinating organisation, for example "Offshore Banking/Financial Commission" could create acceptable rules for offshore banks and self-regulated support and judgement inside of the group. The Commission can also develop public relations with governments and domestic banking associations, and provide legal protection favourable for offshore banks. New technology means a unique chance for fostering offshore banking and due to general changes within the market this will not be recognised as an excessively aggressive signal.
Access to the capital market is a weak point for offshore banks as well for other types of offshore companies. At the same time, the Internet and globalization of offshore banking industry should be complemented by a special vehicle for offshore capitalisation and provision of liquidity on the offshore market. The development of such a vehicle, for example an "Internet Stock Exchange", can be viewed as a critical element in the offshore industry.
7. Conclusion
The technological revolution, which includes microprocessor technology, the Internet, E-money, etc. is completely changing the business conditions of the banking industry. New meaning of generic competitive force could change the whole structure of the banking industry and provide a unique chance for offshore banks to get access to new market segments. The crucial role of technology as the source of competitive advantage will reduce entry barriers and stimulate new entrance to the market. To utilise the new opportunities, offshore banks would presumably create special legal and financial vehicles for protecting their position and capital circulation.
Ilia Karas, London, 20.11.96, Speech on the conference "Offshore - 2000".
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
