The Geneses Of The Offshore Banking Industry

Published Date: 02 Nov 2017

The offshore banking is the deposit of funds by either a company or an individual in a bank which is situated outside their national residence. The geneses of the offshore banking industry are found in a group of island off the northwest coast of France, the Channel Island. Many years back, a group of government officials and bankers decided to propose a remedy against lower taxation together with discretion and anonymity. The intent was to grasp upon the frustration of UK and European residents having enough with overbearingly high rates of taxation and insufficient safeguards to privacy and confidentiality in their home countries. These offshore banking institutions and new offshore financial centers gained instant notoriety and popularity. The Offshore banking sector was born. This spread across Europe and around the world, other small nations and jurisdiction seized upon the opportunity and began strengthening regulations regarding banking practices and client confidentiality in the hopes of attracting foreign depositors; thus becoming offshore banking jurisdictions and offshore financial centers. This became particularly popular in the small island nations which are what many tend to associate with offshore banking jurisdictions. Investors and depositors seeking politically and economically stable jurisdictions found their way to these offshore financial centers and this practice continues today.

Mauritius has been able to find its way in the offshore banking and today most of the banks in Mauritius offer the offshore banking, some banks are new to this service while others have been able to offer this service for many years. As per the Mauritian Bankers Association Limited (MBA, 2006), Barclays Mauritius was established in 1919 and it was the first bank to obtain an offshore banking license in 1989. Prior to December 2004, banks were required to obtain a separate license and there were restrictions on using the domestic currency and operating in the domestic banking environment. The separate licensing requirements for banks engaged in "domestic" and "offshore" banking activities were removed by the new Banking Act, which came into effect in November 2004 as per the Bank of Mauritius enactments(BOM, 2004).

Mauritius has already got itself in a strategy of enhancing its range of financial products and moving towards the provision of higher end and value added services so as to be able to sustain its development as an international financial centre. As per the MBA, Mauritius has nineteen banks which includes of eight foreign owned subsidiaries, six local banks, one Islamic bank, one joint venture, and four branches of foreign banks (MBA manual, 2012). As at the end of June 2011, the total assets of banks stood at USD 29.2Bn and as at October 2011, some 800 Global Funds with an NAV of USD 70.5Bn. 27,057 Global Business Companies has been locally incorporated as at October 2011 and the Financial Services Commission (FSC) has licensed 154 Management Companies as at October 2011 (FSC, Feb 2011).

As at 29 November 2011, the Market Cap of the Stock Exchange of Mauritius has shown a figure of USD 7Bn and international multi-asset class exchange offering a basket of commodities and currency derivative products including energy, metals, currency pairs and agri-soft,(FSC, Nov 2012).

Nowadays, international institutions like the OECD, IAIS, IOSCO, IFSB and the FATF recognise Mauritius as a financial platform. The financial services remain one of the most significant contributors of the Mauritian economy representing 13% GDP and hiring directly over 15,000 highly skilled professionals. The suitable regulatory and legal frameworks together with sufficient level of expertise, attractive fiscal regime and the numerous network of Double Taxation Treaties (DTA) making the island a business friendly and an attractive jurisdiction for investment purposes (BOI, 2012).

2.2 Services and Products offered by Offshore banks

The types of services and products offered by offshore banks are various and mostly similar to what onshore banking offers. Offshore banks offer a wide range of services and products to their clients namely, international money payments through the global swift network in all major currencies, deposit products: term and call deposit accounts, multi-currency cheque book, structured investments, US dollar and EURO deferred debit cards as well as foreign currencies credit cards, internet banking, credit facilities - short term loans and working capital finance, medium and long term loans in a variety of sectors, structured financing, derivatives transactions, foreign exchange and, international trade finance instruments- letter of credit (LC) issuance, bill discounting, guarantees and documentary collections, syndicated loan market, participation in syndicated loan market by actively seeking transactions in Far East /London/ /Africa, custody services and Escrow account services.

As per the FSC report, the different methods available to carry out global business activities from Mauritius are companies holding Global Business Licence, Category 1 (GBC1) and companies holding a Global Business Licence, Category 2 (GBC2). Other entities also available are, protected cell companies, (PCC), trust, Global Funds and limited partnerships.

2.3The regulatory framework of the financial services environment in Mauritius.

Mauritius depending on the circumstances has used the opportunities to intervene and caused the required legislations to be enacted to pave the way for a secured financial environment as the local legislations have evolved towards a more stringent and regulated environment. The FSC is the regulatory body for all non-banking financial services while the BOM is the regulatory body for the banking sectors. One of the objectives of the FSC is to ensure the orderly administration of the financial services and the GB activities which includes, the administration of the relevant acts as well. In addition, it licenses, regulates, monitors and supervises the conduct of business activities in the financial sector and that of the GB. Furthermore, the FSC sets rules and guidance governing the conduct of business in the financial services sector. It identifies and takes measures to prevent and eliminates investment business abuse. It also establishes norms and standards in order to preserve and maintain the good repute of Mauritius. It advises the Ministers generally on any matter relating to the financial services sector and to GB. In doing so, it collects, compiles, publishes and disseminates statistics in respect of the financial services sector. It identifies and maintains such links and liaisons in the field of financial services and GB as may be necessary for the furtherance of its objects. It is to be noted that no person has the right to carry out or hold himself as carrying out any financial services without a license issued by the commission. Any person, who does so, shall commit an offence and shall with the convictions be liable for a fine not exceeding MUR 1.8millions and an imprisonment not greater than 8 years.

The facilities offered to GB companies are numerous. The GBC 1 structure is used generally for investment holding or large scale trading. When income from abroad is generally in the form of capital gains, dividends, royalties and benefits, tax treaties can be obtained. The Effective Income Tax Rate is of 3% and there is neither a withholding nor dividend tax or capital gain tax. While for a GBC 2 company, it is mainly used as a vehicle for holding and managing private asset or for trading purposes. However, the GBC 2 Company has no direct access to the treaty but is still tax exempt but it is not allowed to carry out financial services activities.

As for a trust, when established in the appropriate jurisdiction, provided that residents of the offshore jurisdiction are not included from receiving benefits from the offshore trusts, there will be no local taxes applicable to the earnings of the trust as well as to the asset of the trust. Mauritius offers a low tax jurisdiction and an investor friendly environment to encourage both local and foreign companies for the setting up of a business. The Fiscal Regimes offered, harmonised corporate and income tax of 15%, no capital gains tax, tax free dividend, exemption from customs duty on equipment, 100% foreign ownership, free repatriation of, dividends, profits and capital and 50% annual allowance on declining balance for the purchase of computer equipment and electronic (BOI, 2012).

As per the latest World Bank Doing Business Survey 2012, Mauritius came out first in Africa and 23rd internationally in terms of ease of doing business. Nonetheless, as per the Canadian Fraser Institute Mauritius ranked itself at the 23rd position.

Mauritius is positioned in a suitable time zone permitting business to be conducted in the Far East in the morning, during the early afternoon in the Europe and later in the day for the USA. The country remains one of the fastest growing international financial centre. Mauritius has been a well regulated legislative framework together with an international standard banking sector, with highly skilled professional and the continuous expansion of the double taxation treaty network which have steered to the success of the Mauritian global business sector. With the prevalent treaty network of over 35 countries, the island offers prodigious opportunities to plan investment through the use of the Mauritian global business vehicles. What the treaties provide is attractive concessions for tax planning opportunities such as the elimination of double taxation through tax credit, decrease in withholding taxes on interests, dividends and royalties and the exemption from capital gain tax (MRA Mauritius).

2.4 African Perspective

Africa is becoming gradually an attractive place to invest. At the moment, Mauritius has tax treaties with 13 African states (Lesotho, Botswana, Madagascar, Namibia, Mozambique, Rwanda, South Africa, Seychelles, Swaziland, Tunisia, Senegal, Zimbabwe and Uganda) and is in negotiation with seven other states (Egypt, Congo, Malawi, Nigeria, Burkina Faso, Ghana and Zambia). The numbers of benefits for setting up of an investment vehicles in Mauritius for investments in Africa are numerous through Mauritius are; minimization of withholding tax on dividend through the use of DTA and capital gains tax minimization. Also, free repatriation of investment capital and returns and the guarantee against expropriation under the Investment Promotion and Protection Agreements. Interestingly, there are no exchange control restriction and access to foreign currency loans and advances (MRA, Nov 2012)

So far, Mauritius has concluded 36 tax treaties and is party to a series of treaties under negotiation namely 5 treaties which awaits ratification (Congo, Egypt, Kenya, Nigeria, Russia) and 4 treaties which await signature (Ghana, Monaco, Gabon, and South Africa). Furthermore, 14 treaties are being negotiated with Algeria, Burkina Faso, Canada, Czech Republic, Greece, Hong Kong, Malawi, Portugal, St. Kitts, Saudi Arabia, Republic of Iran & Nevis, Vietnam , Tanzania and Yemen.(MRA, Nov 2012)

Mauritius has signed IPPAs with 15 African member states which offer the right incentive and guarantee to investors targeting to invest in emerging economies such as Africa. The country’s membership in regional organizations, such as the Common Market for Eastern and Southern Africa (COMESA), the South African Development Community (SADC) and the Indian Ocean Rim association for the regional Cooperation (IOR-ARC) and being a signatory to some major African conventions make Manutius as the best offshore financial services centre for the establishment of Investment Holdings Company or any Fund.

2.5 Asian Perspective

DTAs has been put in place with the two largest emerging countries namely China and India. The global business platform is being extensively used for Structured Trade Finance between Africa, Asia, and Middle-East as well as Investment into India. The other facilities which is also offered to Offshore banks in Mauritius by the BOM is that for all those companies which are listed on the stock exchange of Mauritius or Stock Exchange situated outside Mauritius, they are exempt from the KYC procedures. Furthermore, for all those companies which has been struck off or which have had their license revoked are published in the government gazette, thus making the banks aware of the necessary actions to be taken to close down the accounts which is still opened in their books after the procedures have been adhere to.

However, it is noted that the offshore sector are exposed to different types of risks. Those companies mainly transact in foreign currencies and faced with transaction, translation and economic risks. Offshore sector also faces the investment risks which can be categories into two main groups, namely systematic and unsystematic risks.

2.6 An overview of the financial crisis

During the year 2008 and 2009, the financial crisis was a shockwave for the world economy and is actually considered as the most shocking economic transformation after the great depression of 1930s. Developing financial markets have essentially proven resistant to the consequences of the Global Financial Crisis. In an environment where the world economy continues to feel the magnitudes of the Global Financial Crisis, the role of emerging markets has reached unprecedented importance. While much attention has concentrated on the better growth prospects of these nations, the continued build-up of their foreign reserves, and the form and method chosen for their allocation, especially those from the Asia-Pacific region, the situation is more complex and anomalous than it would first seem. For example, many developing nations domiciled in some of the poorest regions of the world, including Africa, the South America and Middle East, are now capital exporters to the developed economies, not only in the traditional form of portfolio investment, but increasingly as Foreign Direct Investment (FDI). The latter brings with it a host of geopolitical issues and concerns. Nevertheless, one thing is now clear, the economic and financial landscape of this century will be shaped not just by the saving and consumption patterns of countries in the developed world but also by the manner and direction of allocation of the wealth that has now been accumulated in many emerging nations. These flows, given their scale and scope, now appear unstoppable.

The crisis which started in US had a systemic effect, affecting the European countries and all the countries. We note that as at date, European countries such as Greece and Italy are still in the eye of the crisis. It could be clearly seen that the eurozone unemployment rate has hit a record high at 11.8% with 18.8m people out of jobs according to Eurostat and youth unemployment at a new high,(Eurostat, Dec 2012). The eurozone unemployment rate rose to 11.8% in November 2012, the highest rate on record according to official figures out. The highest rate was seen in Spain at 26.6% followed by Greece at 26% (recorded for September 2012). According to Eurostat, the unemployment rate increased in 18 of the EU member states, fell in seven and remained stable in both Denmark and Hungary. The latest figures from Eurostat, the statistical office of the European Union, also show the EU27 unemployment rate stood at 10.7% in November, stable compared with the previous month.(Eurostat, Dec 2012)

It all started in US where a low interest rate regime together with a large inflows of foreign funds for construction of houses were encourages by high debt-financed in the US. Hugh amounts of loans have been granted to the US citizens without taking into consideration their repayment capacity. According to Gorton and Winton (1998), early reforms in majority of the emerging economies were influenced by the existence of large percentage of bad loans and risky credits.

The banking system provides the support around which the economy turns. It underpins the efficient allocation of capital stock, provides essential transaction and intermediation services and funds the development of new businesses and technologies in the wider economy (Harper and Chan, 2003). As at the late 1990s, according to Mihaljeck (2006, p. 46), the banking systems of many emerging market economies were highly fragmented in terms of the number and size of institutions, ownership patterns, profitability, and competitiveness, use of modern technology, and other structural features. Several scholars studied the ethical issues related to the global financial crisis from various perspectives. Buiter (2007) pointed out that the crisis was the product of a perfect storm bringing together a number of microeconomic and macroeconomic pathologies.

Researchers found out that a failure in ethics has contributed to the crisis. Wesberry (2009) related the crisis to ethical and cultural decline while, Longstaff (2008) revealed that negative values of, cheating, lying, using power oppressively and financial dishonesty had distorted the free market leading to the crisis. Gilani (2009) stated that the compensation-defined culture of Wall Street led to the crisis. These above named researchers called for a stronger values system to prevent such crisis. Benton (2009) in this regard emphasized that it is necessary to empower employees to stand in opposition, to question, to push, and to think morally about ways to meet corporate goals in order to create an ethical financial system. The need of the hour is to develop a better work ethic, reduce greed and be conservative (Robinson, 2008). Sen (2009) argued that the crisis raised concerns whether capitalism in its current form needs revision. The crisis necessitated economic organizations to go beyond providing short-term solutions to enabling creating a more decent world.

Following high market volatility with prices of stocks going more and more speculative, banks, mortgage companies and insurances were unable to pay back their debts. The problem is in such a magnitude that those banks even with large capital reserves ran out, we could here make reference to the closing down of the Northern Rock Bank in UK, 2007 which actually closed its doors due to insolvency. This systemic effect of insolvency, lead to the ruin of even the wealthiest economies which had to come up with rescue packages to bail out their financial systems (Moshirian,2009).

For Chan Lau (2008), the financial quake shakes the ailing US economy and run the risk of a major bankruptcy. European economies which were well aligned with their American counterparts in the form of overseas subsidiaries and affiliates were eventually vulnerable by the crisis and it was predicted that emerging economies in the developing world would also suffer from the changes.

In the first few months of the financial crisis, there was the widely held view that the impact on African countries would be minimal as we thought that African countries being far from those big countries such as the US and the European countries, as there is less exposure to complex financial products. Yet, we note that we were wrong and that indeed African countries were impacted by the crisis. This has been confirmed by, Ramlall (2009) who showed that with the crisis, the main index of the Mauritius stock market, SEMDEX, had become more sensitive to movements in international stock markets. He went further as to account for the retreat by foreigners made during the crisis on the back of undermined international portfolio diversification.

However, as the crisis continued leading to an economic slowdown, risks could grow as the banking sector remains defenseless to reduction in income and debt servicing capacities as well as problems faced by the sectors which are pillars to the economy. According to Kamara and al. (2009) African countries have been taking several measures to mitigate the impact of the crisis on their financial institutions , including interest rate reductions, recapitalization of financial institutions, increasing liquidity to banks and firms, fiscal stimulus packages, trade policy changes, and regulatory reforms.

Larose (2003) showed that during the Asian financial crisis in the late 90’s, remote small island economies like Mauritius faced downtowns in their stock markets although they were not connected with the origins of the crisis. Mauritius is presently more open to the global slowdown arising from the financial crisis due to the growing interdependence of its financial institutions into a global market place. The global economic recession is likely to continue to hold back the island’s economic growth. Mauritius is a small, export-driven country and the sharp decrease in export volumes during the latter half of 2008 and the first quarters of 2009 has already had a major impact on industry.

The pace of globalisation over the past quarter century is reflected in the degree to which trade has outpaced world growth since the 1980s (OECD, 2007), the increasingly global production networks and supply chains (De Bakker & Yamano, 2007) and the acceleration in foreign direct investment (FDI) since the 1990s (UNCTAD, 2010).

As per the Mauritius ICT Export Portal, it has been proved that the developments in the ICT sector have so far been rapid, sustained and above all very encouraging. Unlike other sectors of the economy, the ICT sector in Mauritius has been robust to the present financial crisis and is today a fast growing and promising sector with a huge potential for job and wealth creation. As per the World Bank Doing Business Survey 2012, Mauritius came out 23rd out of 183 countries and came out first out of the 53 African countries in the Ibrahim Index of African Governance 2011. Also, for those International banks, whose parent company are faced with the crisis or have been directly impacted by the crisis transmit their strategy and expertise to those bank implanted in Mauritius. Barclays cuts 285 UK jobs transferring back office roles to India. (The Guardian, 2 Feb 2011). This is one example whereby what is being implemented in other countries by International banks are also implemented in Mauritius. The response rate provided is in line with the same section.

Today, any foreign investor can set up a company hassle-free in Mauritius and be operational in just 3 working days. Mauritius offers a business environment which is very conducive to business growth and investment. Mauritius has secured preferential market access to the European Union, the USA through the Southern African Development Community (SADC), Africa Growth and Opportunity Act and the Common Market for Eastern and Southern Africa (COMESA) and. To facilitate business and commercial activities, Mauritius has a very well-built infrastructural network comprising of an extensive and well maintained road infrastructure, a modern and efficient port capable of berthing vessels up to 100 metres, direct air connections with several cities throughout the world; high bandwidth fibre cable connectivity and a reliable fixed and mobile telephone network.

As per Rundheersing Bheenick, the governor of the BOM in the Letter to stakeholders, Bank of Mauritius, Port Louis, December 2008 where he mentioned that, Mauritius has not of course entirely escaped the spillover effects of the global crisis on the real economy. Indeed, the impact is becoming increasingly visible. A slowdown is being witnessed in the levels of production and investment in Mauritius.

2.9 General Anti-Avoidance rule (GAAR)- India.

GAAR is a new chapter which has been introduced in the Finance Bill 2012 of India. GAAR is a simple rule which allow the Indian tax authorities to levy tax if the arrangement or transactions done are "impermissible avoidance arrangements": the first one is the main purpose test and the second is the specified condition test. The main purpose test is to obtain tax benefit. And in addition to the first condition, there is the specified condition test which must satisfy any one or more of the following conditions: there has been abuse or misuse of the provision, the agreement or transaction is non-arm length or the agreement or transaction is not bonafide or they lacks commercial substance. In other words, the above points mean that one should not get into agreement for which the main purpose is to obtain tax benefit. For example, many of the companies are nowadays converting themselves into Limited Liability Partnership (LLP) where there are tax benefits like lower tax rate, absence of dividend distribution tax. Hence, companies that have converted into LLP might face adverse consequence if the arrangement is not for bonafide commercial purpose which will make the burden lie on the tax payer.(GAAR, 2011)

Furthermore, the finance bill has provided little guidance as to what the misuse and abuse of the provision mean. For example, it could be considered as cross-border mergers wherein foreign companies take over Indian companies for tax benefits or vice versa. This may be considered as an exposure to GAAR. Hence, proper business rational and proof should be documented to avoid such as situation.

Under the provisions of GAAR, no clear definition of commercial substance has been specified which further gives unrestricted powers to the tax authorities to interpret the term, resulting into a losing situation for the tax payers.

The provisions made under GAAR still do not have much clarity but may have an impact on many companies. This has led to creating negative sentiments in the environment. Foreign institutional investors, which were the net buyer in the initial month 2012, are now being the sellers since there is still high uncertainty about their investments. There is also news in the market that the investments made through the Mauritius route might also come under the eye of the GAAR.

3. Methodology

It has been perceived that past studies done to assess the impact of the financial crisis on the financial sector in Mauritius are few and only few scholars have as at date assess the impact of the crisis on the offshore banking sector in Mauritius. The offshore sector has much developed and has become one of the pillars of the economy. To be able to assess the impact of the financial crisis in the offshore sector of different banks, a questionnaire has been designed containing specific questions to gauge whether these banks have been impacted by the financial crisis or not and whether they have been proactive in view of curbing the adverse effect of the crisis both moneywise and as well as in terms of human resource. Banks which already existed for the past five years have been chosen and preference has been given to those international banks implanted in Mauritius such as the Deutsche Bank, Barclays Bank PLC and the Standard Bank (Mauritius) Ltd. These International banks have their offshore department well set up in Mauritius earlier than those locally incorporated banks and with the years, these banks have been able to grow in terms of client portfolio.

A well designed questionnaire containing 15 well-structured open ended as well as closed ended questions were sent out to the Head/Senior Relationship managers of the Offshore Department/ Global Business Desk of the ten banks in Mauritius. However, we should point out that the response rate was low and only 5 banks reverted back to us and the other banks did not respond due to confidentiality issue. We were therefore left with five banks of which, there is only one local bank and the remaining are International banks. It has been observed that those international banks having their brand name globally known are mostly those who have been in the offshore banking in Mauritius well before the local banks. Those international banks carry their name as a strong marketing tool to attract foreign investment and obtain publicity by their subsidiaries situated in different parts of the world. However, none of the responding banks offer Islamic banking, and as such, the analysis was therefore restricted to the normal banking sector only and there was no possibility to make comparative analysis which was one of our initial objectives.

Together with the primary data collected as per the questionnaires, an analysis of how was the behavior and reactiveness of these banks to the financial crisis was done. Besides, all the available information were gathered as per the past annual reports published by banks starting from the year 2006 to 2011 to gauge the impact of the financial crisis to these banks in terms of their profitability, liquidity Return of Capital Employed, gearing, asset turnover ratios. An analysis of the ratios to make a comparison between Barclays Bank Plc. and The Standard Bank (Mauritius) Ltd has been done. These two banks have been chosen as Barclays Bank Plc., is amongst the first bank to offer Offshore banking in Mauritius, while Standard Bank (Mauritius) being an international bank as well has just implemented itself in Mauritius couple of years bank. The use of the excel tool has been used to make diagrammatic illustrations of the findings. The analysis has been subdivided into two parts, the first being the result obtained from the questionnaires and the second from the published financial statements of the different banks. Likewise, the data that have been collected from the website of the UNCAD to identify the level of Foreign Direct Investment (FDI) flowing into the country and to know whether the level of FDI has been affected by the financial crisis taking into consideration that Mauritius is amongst those countries which encourage FDI. In other words, the healthiness of the offshore banking sector is going to be assessed: whether the banks have been able to resist the financial crisis and to which extent. What are the strategies which the banks have put ahead so as to mitigate the impact of the crisis if in case they have been affected.

The liquidity ratios calculated gives an indication as to whether or not a company will be able to meet its commitments as it fall due. Please note that the total Asset and total liabilities has been used to calculate the Current Ratio. In practice, the current asset/current liabilities is used. And for the Quick Ratio(Acid test) the cash and cash equivalents have been used since the inventories should be excluded.

For those offshore banks operating in Mauritius, such as the Barclays Bank PLC and The Standard Bank (Mauritius) Ltd, their financial statements show the actual figures with regards to the offshore sector since this is their main business activity which is the offshore banking. Nonetheless, this is not the situation for the local bank whose financial statements consist of the revenue from all the other segments of the bank, such as the domestic corporate banking, the retail banking etc. In such a case, if a comparison has to be done, the figures as per the financial statement of Standard Bank (Mauritius) Ltd and that of a local Bank such as the MCB Ltd will not correspond. In such a case, this is to be considered as a constraint in the analysis being done.

The strategy that an organisation has implemented differs from one another. The way and the extent to which the manager of Bank A interprete the impact of the global financial crisis is different depending on the type of investment and on the type of clients which the organisation will take on board. Discussing by way of questionnaire is very fruitful as it is a very rich instrument. An assessment was made on the personal opinion of the managers about the prospect of the offshore sector in Mauritius as well as the time it which will take for the financial crisis to prevail.