Philippines Experience in Offshore Banking

Offshore banking refers to the use of a bank located outside one’s country of residence, typically in tax havens, for financial services. It provides depositors with confidentiality and security. The English originally used the term “offshore” to describe tax havens in the British Channel Islands off the coast of Great Britain. These banks played a significant role in developing tax-saving strategies, leading to the expansion of the term to encompass the entire industry.

These islands have become prominent global banking centers because of their tax advantages and other benefits. They are now the preferred destinations for holding assets, saving, and investing. Unlike many countries, the local governments of these islands have fewer regulations on banking. This freedom allows depositors to easily manipulate various types of offshore banking accounts based on their preferences. Offshore banking plays a significant role in the global financial markets with a daily circulation of approximately $2 trillion.

The business has made significant strides since its modest origins a few decades ago, when only a handful of such centers existed. In that era, there were frequently tales of drug money and illicit funds being utilized. Offshore banks offer the same array of services as traditional banks, encompassing both corporate and personal checking accounts. Furthermore, they furnish secure Internet banking functionalities for electronic transactions, such as fund transfers, globally recognized debit and credit cards, in addition to loans and mortgages.

Certain facilities provide anonymous numbered accounts for maximum confidentiality. In addition, specific banks offer investment management and custodial services, as well as foreign exchange dealings, corporate administration services, trustee services, and funds management. It is important to highlight the distinction between retail and private banking since not all banks offer identical services. Retail banks are more cost-effective and provide standard services while private banks may be more expensive but provide personalized services for their clients.

Offshore banking provides multiple benefits such as increased privacy and tax advantages. Unless criminal activity is proven, offshore banks have no obligation to reveal personal or corporate details, ensuring strong privacy. Government bodies and tax authorities lack the ability to obtain information from these banks or pursue legal action against account holders. Moreover, as offshore banks are frequently situated in tax havens, investments can thrive without incurring taxes, resulting in substantial tax savings.

It may be necessary to pay taxes if the funds are brought back into the country of residence. However, your assets are fully protected. Your banked assets are shielded from invasive bureaucracy, lawsuits, and seizures. Offshore banking can be better described than defined. With the growth of international banking in recent decades, banks involved in international finance have found it convenient and efficient to rely on booking centers that provide cost-effective facilities and tax advantages.

The importance of regional location is that it provides certain countries with enhanced benefits due to specific geographic advantages. Additionally, these regions offer timing advantages for fund placement and generation, increasing efficiency in the global capital market. With advanced international communications technology, transactions can now be completed quickly within seconds, allowing for effective transfer of funds across different time zones throughout most of the world’s 24-hour working cycle.

The banking industry has undergone advancements and offshore banking centers have risen due to specific factors, resulting in the emergence of distinct offshore banks. In countries supporting these banks, they are limited in certain activities compared to domestic banks. However, offshore banks are exempt from regulations on interest rates and reserve requirements that local banks must adhere to. It is important to mention that the Philippines did not have any offshore banks prior to 1976.

Although the Philippines has limited experience in offshore banking, it has achieved its initial targets and gained significant attention in financial policy-making. Understanding this matter requires examining the reasons for establishing offshore banks in the Philippines, their benefits, future financial operations, and most importantly, their impact on the local Philippine economy.

The growth of offshore banks in the Philippines has presented banking policy with fresh financial obstacles; however, their potential expansion is presently jeopardized by the ongoing economic crisis. The establishment of these offshore banks can be traced back to 1946 when political independence was attained, consequently leading to the establishment of central banking and the enactment of the commercial banking law in 1949. Consequently, there was a notable surge in the Philippine banking sector with an upsurge in domestic banks.

The primary objective of commercial banking policy in the Philippines was to restrict domestic banking to Philippine banks and promote the expansion of private banking. Consequently, domestic private banks were established and encouraged. Foreign banks were not allowed to operate within the domestic economy, with the exception of four banks that were already present in the country prior to the enactment of the commercial banking law. Additionally, no new foreign branch banking was allowed.

This paragraph examines the significant roles played by Citibank, Bank of America, the Hong Kong and Shanghai Bank, and Chartered Bank in the commercial banking industry of the Philippines. These banks were granted permission to operate as branches within the country prior to enhancements being made to the national commercial banking act. As time went on and the financial sector grew, certain flaws became evident in the local economy. One notable issue was that many domestic banks within the banking sector lacked adequate capitalization.

The banks had limited capability to fund the growing economy due to their lack of knowledge in advanced banking methods and limited interaction with international banks. This was because the domestic banks lacked sufficient capitalization and market goals, resulting in a narrow perspective and untapped potential. However, it was crucial for these banks to play a more active role in financing national economic activities.

In 1972, a survey on financial sector reforms suggested that banks should increase their capital base. To meet this goal, commercial banks were mandated to raise their capitalization to a specified minimum limit. One method proposed was to permit increased involvement of foreign entities in owning domestic commercial banks. However, such foreign interests were limited to holding a maximum of 40 percent of the total capital.

The program led to domestic commercial banks and certain Philippine banks experiencing a boost in their capital base, while some foreign banks became minority stakeholders. However, worries emerged regarding the country’s capability to access international financial markets efficiently without the participation of foreign banks. Consequently, an extensive investigation was conducted to assess the possibility of establishing offshore banks in the Philippines. The creation of an offshore banking system was deemed beneficial for the nation as it would strengthen its connectivity with significant global financial institutions.

The program aimed to offer young bankers valuable experience in international finance and training. It also aimed to transfer banking technology and practices to the domestic banking sector through interactions with offshore banks. Additionally, it was believed that offshore banks would contribute to Manila’s development as a prominent financial center in Southeast Asia and the Pacific region.

The government recognized the growth of other cities as finance centers in the region and saw potential for more areas. It acknowledged that competition exists in this growth, but also emphasized the importance of centers complementing each other not only in the region, but also globally. In 1976, the Philippines allowed the establishment of offshore banks. The law governing this recognized several factors that would make offshore banking an attractive operation in the country.

Policymakers recognized that Manila had certain disadvantages compared to other existing centers, but they aimed to make it slightly more appealing. To achieve this, they provided certain tax incentives. Later in this text, we will further delve into these advantages and disadvantages. The Central Bank developed guidelines to attract foreign banks to establish offshore banks in the country. This offshore banking law was implemented during a period of significant growth in international banking.

Due to the substantial surplus of petrodollars, the Eurodollar market has been remarkably liquid. In order to guarantee the liquidity of offshore banking units (referred to as OBU’s), each OBU was mandated to maintain a minimum net fund of US$1 million. The incentive structure for OBU’s has been carefully crafted and continuously developed over time to increasingly create an appealing operating environment for them. To ensure proper training of Filipinos in this newfound financial endeavor, OBU’s were also obligated to hire Filipino nationals while having the option to employ expatriate personnel.

After a learning process, it was expected that Philippine nationals would become actively involved in the profession. By January 1983, the Philippine Central Bank had approved 28 banks to establish OBU’s and 26 of them were already operating. Some notable institutions among them were Banque Nationale de Paris, Manufacturers Hanover, Chemical Bank, Bank of Tokyo, Barclays, Credit Lyonnals, and Chase Manhattan Bank.

Offshore banks in the Philippines, like other similar systems globally, have the ability to participate in offshore fund generation and foreign currency placements. These banks can also engage in these activities with each other and the Foreign Currency Deposit Units (FCDU’s) of Philippine banks. Additionally, they can engage in foreign currency-denominated lendings to Philippine residents, as long as they obtain approval from the Central Bank. Offshore banks in the Philippines are also authorized to handle the importations of residents, with a minimum amount of US$1 million, which is funded by the same Offshore Banking Unit (OBU). They are also permitted to provide financial advisory and related services.

The OBU in the Philippines has the ability to engage in foreign exchange trading, discount bills, invest in foreign securities, and debt instruments of nonresidents and other OBU’s. Their loans to offshore accounts have no limit. Additionally, OBU’s play a crucial role in handling foreign exchange remittances, which is vital to the Philippine economy due to the growing number of Filipino workers in the Middle East. Furthermore, OBU’s indirectly participate in the peso lending market as their placements with domestic bank’s FCDU’s are converted into pesos for onlending purposes.

However, this facility is only available through currency swaps approved by the Central Bank for OBU lending to onshore accounts. This facility played a crucial role in financing domestic liquidity and providing the Central Bank with external liquidity during balance of payments crises in the Philippines. Additionally, by allowing for greater flexibility in the financial position, OBUs have been instrumental in financing the Philippine economy.

An external critic may argue that this created instability in managing the Philippine balance of payments. While it expanded options for external financial management, it also caused significant short-term instability when funds ceased. Unlike two other financial centers in the region, Hong Kong and Singapore, the OBU’s cannot accept deposits in local currency. There are several factors that influence the positioning of financial offshore centers.

In regards to the offshore centers located in Singapore and Hong Kong, Manila is a smaller center and is expected to remain so for many years. These factors both aid and hinder its current growth, which any institution that has established its OBU operation in Manila is aware of. It may be beneficial to highlight several of these factors, which include: (1) relative cost and tax incentives; (2) telecommunications infrastructure; (3) time zone difference; (4) host country’s resource endowments and commercial base; (5) depth of the financial market; and (6) consideration of sovereign risk.

Among the factors mentioned, the Philippines lacks advantage in several areas. Specifically, certain advantages like tax incentives and economic potential are outweighed by drawbacks such as inadequate telecommunications and limited financial resources. Moreover, considerations of sovereign risk have arisen due to factors linked to the recent financial crisis. 1. Cost and tax incentives Financial institutions face a trade-off between operation expenses and income opportunities. Manila provides the most extensive tax concessions.

This is further supported by the affordable housing and low salaries for local workers in Manila. However, Manila has the fewest commercial banking activities compared to the other two centers, which limits trading and business opportunities. Tax benefits for Philippine OBU’s are comparable to Hong Kong and Singapore, with a previous offshore income tax rate of 10 percent that has recently been suspended for five years, with a possibility of extending the tax-exemption period.

This could be a response to the competitive tax environment, aiming to strengthen Singapore’s position in the region. Additionally, both Singapore and Hong Kong have advanced telecommunications infrastructure comparable to developed countries. On the other hand, the Philippines lacks satisfactory telecommunications, transport, and utility infrastructure. Among these, telecommunications is particularly problematic as it can be expensive and occasionally unreliable.

Bank dealers understand that communication, particularly quick access to it, is crucial for successful trading operations. Time Zone differences play a significant role in global forex trading. Tokyo begins trading as the U.S. West Coast closes, and if cities like Honolulu, Sydney, and Melbourne could bridge the gap between the two sessions, forex trading would occur continuously around the world. Additionally, Manila, Hong Kong, and Singapore all start trading at the same time.

Singapore has intentionally adjusted its official time forward by thirty minutes, eliminating any prior time advantage held by Hong Kong and Manila. Bahrain, on the other hand, starts five hours later, bridging the gap between the closing of Asian markets and the opening of European markets. Additionally, Manila, being the capital city of a country with a population twenty times larger than either Hong Kong or Singapore, possesses a diverse range of natural resources including agricultural land, offshore petroleum, and geothermal power. In contrast, Hong Kong and Singapore are both city states.

The city states have a higher level of commercial development compared to Manila. These cities serve as main ports for international trade of goods, services, and capital. Manila, in contrast, primarily functions as an international port for the Philippines. The strategic geographical locations of the city states, coupled with their successful economic growth driven by favorable policies for foreign and domestic capital, have highlighted their significance in trade between the Asia-Pacific region and the rest of the world.

As a result of the trade values passing through its ports, the business of multinational corporations in Singapore and Hong Kong far surpasses that of Manila. This can be attributed to the relative small size of these city states and the concentration of their trading and manufacturing activities. This has allowed them to enhance their telecommunications and infrastructure more efficiently compared to countries with larger hinterlands in the region, such as Thailand and the Philippines.

The existing infrastructure also contributes to the appeal of these financial centers in a positive cycle. However, Manila needs to overcome obstacles in capital requirements for telecommunications and infrastructure, despite having significant economic potential. Multinational companies in Manila mainly focus on long-term investments in natural resource development or import substitution industries. Only recently has the manufacturing sector seen the emergence of new enterprises engaging in foreign trade activities, such as exports.

International commercial banks tend to favor trade financing, specifically the documentary type of credit business, over project or country lending. The depth of a financial market is crucial as it determines the complexity and range of financial transactions and instruments that can be conducted. This is directly tied to a country’s level of economic development, as a higher level of economic development leads to the growth of financial markets. Hong Kong and Singapore are examples of well-developed markets that have benefited from their higher economic levels.

The development of the financial market is significantly influenced by the licensing and regulatory framework. Currently, the Philippine market allows the fewest number of transactions due to its relative newness. This could be considered a disadvantage as it is important to protect and gradually introduce the underdeveloped Philippine economy to the offshore system. On the other hand, Hong Kong’s financial markets have a substantial depth that extends beyond China, Taiwan, South Korea, and other parts of the region. Additionally, banks consider sovereign risk as a significant factor in their estimations.

The importance of this factor is demonstrated in the case of Singapore, where there is a significant queue of individuals wanting to establish offshore banks. Singapore has gained a strong reputation due to its prolonged period of political stability, particularly since the late 1960s. The uncertainties surrounding Hong Kong’s future may have caused some bankers to adopt a cautious approach when sovereignty issues arose in 1997. However, it is also noteworthy that financial institutions with long-term commitments in Hong Kong have not been greatly affected by these developments, highlighting the maturity of Hong Kong’s market.

At present, Manila’s future is uncertain due to recent political events and negative economic news. The resolution of political issues is crucial for determining the sovereign risk for banks and investors, but it is less complicated for the Philippines as these issues can be resolved internally. However, in the case of Hong Kong, where external political factors are beyond a country’s control, there may be greater uncertainty in the long term.

The outcome of the bilateral negotiations between Britain and China will significantly shape Hong Kong’s future. Unfortunately, China has a strong advantage in these negotiations. Therefore, Hong Kong’s ability to determine its own destiny is currently influenced by external factors beyond its control. It is important to consider that Manila’s role as a financial offshore center is still in its early stages and is likely to lag behind the more advanced markets in Singapore and Hong Kong.

Manila’s future growth in offshore banking is hindered by several inherent disadvantages. One of these is the relatively low level of economic development, despite the larger potential economic base of the Philippines. Another obstacle is the poor communications infrastructure in Manila, which continues to hamper its role. However, there are plans to implement improvement programs for better telecommunications in the future. Additionally, the natural growth of the economy will arise as it emerges from the present economic difficulties that have plagued the country, notably in 1983 when a debilitating external debt crisis occurred.

These new problems will impact the financial system, including offshore banks. The existing banking infrastructure will contribute to the growth of offshore banking, but there are important issues that arise from the entry of offshore banks and the debt crisis. Resolving these problems could influence the nature of offshore banking in the Philippines.

The text outlines the Consolidated Foreign Exchange Rules and Regulations Part III, specifically focusing on Offshore Banking Units (OBUs), Representative Offices, and FCDUs (Foreign Currency Deposit Units). Chapter I of the regulations pertains to Offshore Banking Units of Foreign Banks. The section defines certain terms used in this chapter. “Offshore Banking” refers to conducting banking transactions in foreign currencies involving funds received from external sources, including internal sources as allowed. An “Offshore Banking Unit” or “OBU” refers to a branch, subsidiary, or affiliate of a foreign banking corporation authorized by the Central Bank of the Philippines to conduct offshore banking business in the country. “Net office funds” refers to the net credit balance of the “Due to Head Office (HO)/Branches/Parent Company Account” after deducting the “Due from HO/Branches/Parent Company Account” as computed by remittances, advances, deposits from the HO/Branches/Parent Company, and unremitted earnings of OBU.

Total $xxxxx Less: Due from HO/Branches/Parent Company Remittances/Advances/Deposits of OBU with its HO/Branches/Parent Companyxxxxx Net Office Funds$xxxxx 4. “Deposits” shall refer to funds in foreign currencies which are accepted and held by an OBU in the regular course of business, with the obligation to return an equivalent amount to the owner thereof, with or without interest. 5. “Resident” shall mean —
a. an individual citizen of the Philippines residing therein; or
b. an individual who is not a citizen of the Philippines but is permanently residing therein; or
c. a corporation or other juridical person organized under the laws of the Philippines; or
d. a branch, subsidiary, affiliate, extension office or any other unit of corporations or juridical persons organized under the laws of any country and operating in the Philippines.

6. The term “non-resident” refers to an individual, corporation, or other juridical person not included in the above definition of “resident”.
7. “Foreign currency deposit unit” or “FCDU” refers to a unit of a local bank or a local branch of a foreign bank authorized by the Central Bank to engage in foreign currency-denominated transactions, as specified in R. A. 6426, as amended. “Local bank” refers to a thrift bank or a commercial bank organized under the laws of the Republic of the Philippines. “Local branch of a foreign bank” refers to a branch of a foreign bank conducting business in the Philippines, according to the provisions of R.

A. No. 337, as amended. 8. “Acceptable foreign exchange” refers to foreign currencies that are acceptable to and exchangeable at the Central Bank and are part of the country’s international reserves.

SECTION 46 states that a foreign bank can establish an offshore banking unit (OBU) in the Philippines after obtaining a Certificate of Authority from the Monetary Board and registering with the Securities and Exchange Commission.

SECTION 47 outlines the criteria for granting a certificate of authority to operate an offshore banking unit. These criteria include assessing the bank’s liquidity and solvency positions, net worth and resources base, managerial and international banking expertise, contribution to the Philippine economy, and other relevant factors such as equity participation in local commercial banks and appropriate geographic representations.

SECTION 48. Pre-Operation Requirements. Upon the advice of the Central Bank, a qualified bank must provide a sworn undertaking, supported by a resolution from its board of directors and the head office or parent company, through any authorized officers, stating that it will: 1. supply the necessary currencies to cover liquidity needs and any shortfall incurred by its OBU upon request. 2. prudently and soundly manage the operations of its OBU. 3. continuously train a specific number of Filipinos in international banking and foreign exchange trading to reduce reliance on expatriates. 4. maintain a minimum net office funds amount of US$1 million in its offshore banking unit at all times. 5. commence operations of its OBU within 180 days from receiving the certificate of authority. 6. adhere to local labor and employment laws. 7. submit additional documents as requested by the Central Bank prior to commencing operations, including certification or similar documents proving authorization from the relevant government entity in its home country to engage in offshore banking in the Philippines.

SECTION 49. The Central Bank requires an authorized bank operating an OBU in the Philippines to pay an annual fee of at least US$20,000.00 upon issuance of a certificate of authority and every year thereafter.

SECTION 50. An OBU has the freedom to engage in all regular banking transactions with non-residents and/or other OBUs, regardless of the currency involved, excluding the Philippine peso.

SECTION 51. Subject to Central Bank regulations, an OBU can conduct the following transactions with local banks incorporated or registered in the Philippines as FCDUs, using any currency other than the Philippine peso:

1. Accept time, demand and call deposits or issue negotiable certificates of time deposits.
2. Borrow with maturities not exceeding 360 days.
3. Deposit.
4. Extend loans and advances.
5. Deal in foreign currency instruments.
6. Discount bills, acceptances, and negotiable certificates of deposits.
7. Engage in foreign exchange trading.

Engage in other authorized transactions under this section between OBUs and resident banks authorized to accept foreign currency deposits under R. A. No. 6426, as amended.

Interbank short-term transactions not exceeding 360 days, such as credit lines of Philippine banks with correspondent banks, interbank call loans, and interbank loans for general liquidity purposes, do not require prior approval from the Central Bank.

SECTION 52. Transactions with Residents which are not Banks – An OBU may engage in the following transactions with residents who are not banks:

1. Deal in foreign currency instruments.
2. Extend foreign currency loans and advances, subject to existing regulations on foreign borrowings.
3. Open letters of credit (L/Cs) for importations of resident-borrowers, provided the importations will be funded by a Central Bank-approved OBU foreign currency loan to the resident borrower involved.
4. Negotiate inward (export) Letters of Credit (L/Cs) and handle other export transactions (including documents against acceptance [D/A] and documents against payments [D/P], and open account arrangements [O/A]) coursed through their worldwide network of branches and correspondents, subject to the following conditions:

OBUs are required to bring in foreign exchange from outside the Trade Facility and sell it to the domestic banking system. Additionally, OBUs are only allowed to have a share in ½ of the growth element in the country’s total annual export business through L/C negotiation. This limit must be followed every year until it reaches 10 percent of total exports. Any exports not covered by L/Cs, such as those done through documents against acceptance/open account arrangements, are also subject to this overall limit.

Offer comprehensive foreign exchange services for both non-trade remittances in foreign currency, and trade remittances resulting from or connected to their own negotiations of export L/Cs. Additionally, provide financial, advisory, and other related services. Refinance trust receipts without prior approval from the Central Bank, arising from import transactions of Philippine residents in U.S. dollars or other acceptable foreign currencies. Such refinancing will be supported by bankers acceptances. SECTION 53. Peso Deposits. — OBUs have the right to open and maintain peso deposit accounts with domestic agent banks exclusively for the following purposes:

To meet administrative and other operating expenses, such as salaries, rentals and the like. To pay the peso equivalent of foreign exchange sold by beneficiaries of inward remittances of Filipino overseas workers or of Filipino or multinational companies, coursed through the OBUs’ correspondent banks abroad. To pay to the designated beneficiaries in the Philippines the peso equivalent of foreign exchange inward remittances other than remittances related to trade. To pay the peso equivalent of foreign exchange sold by beneficiaries of export L/Cs negotiated with the OBUs.

The funding of peso deposit accounts is limited to inward remittances of foreign exchange that are eligible to be included in the Philippine international reserves. OBUs have the option to sell inward remittances of foreign exchange for pesos to the Central Bank through the Treasury Department and have them credited to the demand deposit account of the designated commercial bank on behalf of the OBU. Additionally, OBUs are allowed to provide financial assistance, such as real estate, car, and personal loans, to their officers/employees.