Off Shore Banking

OFFSHORE BANKING
Offshore Banking Centers:
In todays highly integrated global network, international offshore centers have being
a vital role in facilitating investment worldwide. An offshore center exists by usage & is known as Offshore Financial enters !OF s". Offshore #anking enters are also known as Offshore #anks enters, which conduct a wide range of business activities such as banking, insurance, securities transactions, trusts and some non$financial activities such as shi%%ing registries, etc& Offshore #anks deal mostly with FIs and transact wholesale business denominated in currencies other than that of the country hosting the OF s. 'he activities are carried out through offshore branches or subsidiaries. 'hese branches collect de%osits from various markets and channel them for various uses. 'hese branches were engaged mainly in develo%ing (uro urrency loans, including syndicated loans and de%osits, underwriting of eurobonds and Over 'he ounter !O' " trading in derivatives for risk management and s%eculative %ur%oses. 'he bulk amount of business for offshore banking o%erations was generated by (uro urrency transactions. 'hese transactions were involved between ) ty%es !i" between banks and original de%ositors, !ii" between banks and ultimate borrowers and !iii" between banks themselves on the inter bank market. *rivate #anking is one of the ma+or services offered to high net worth %ersons. 'he s%eciali,ed services %rovided include asset management, estate %lanning, foreign exchange trading, custodian and trustee services. 'hese units offer various advantages to non - residents. OF s are exem%t from a wide range of regulations, which are normally im%osed on onshore institutions. .%ecifically, de%osits are not sub+ect to reserve re/uirements. #ank transactions are normally exem%t from regulatory scrutiny with res%ect to li/uidity or ca%ital ade/uacy. An Offshore #anking 0nit !O#0" of a bank is a deemed foreign branch of the %arent bank situated within India, and shall undertake International #anking business involving foreign currency denominated assets and liabilities. 'he 1#I has given %ermission to certain select #anks in India, fulfilling certain criteria, to set u% O#0s in 2 .%ecial (conomic 3ones4 !.(3", for facilitating ex%orts from India.

Types of OFCs:
*rimary OF s5 'hey are large international full service centers with advanced settlement and
%ayment systems, o%erating in li/uid regional markets where both the sources and uses of funds are available. 6ondon, 0. and 7a%an have such centers. Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

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.econdary OF s5 'hey differ from *rimary OF s in only one %oint that they intermediate funds in and
out of their region. In other words, secondary OF s main look will be on whether the region has a deficit or sur%lus of funds. .uch OF s include 8ongkong, .inga%ore, #ahrain, 6uxembourg etc&

#ooking OF s5 #ooking OF s do not engage in the regional intermediation of funds, but rather serve
a registries for transactions arranged and managed in other +urisdictions. 'hese OF s are sometimes referred to as tax heavens and include most aribbean OF s.

Offshore Banking in In3ian Conte4t " Spe ia% E ono5i 6one:

Offshore #anking has taken a great sha%e in India since 9::9. 'he seeds for OF s
were sown in the (;I< *olicy 9::9 - :=, where the >ovt has targeted to achieve the growth in ex%ort target from the %resent :.?=@ to A.::@ of the world trade. 'he >overnment of India has introduced the .%ecial (conomic 3one !.(3" scheme with a view to %rovide an internationally com%etitive and a hassle free environment for ex%ort %roduction. As %er the >overnments %olicy, .(3s will be a s%ecially made duty free enclave and deemed to be a foreign territory for the %ur%ose of trade o%erations and dutiesBtariffs so as to usher in ex%ort$led growth of the economy. Offshore banks are the foreign branches of Indian #ank located in India.

Chara teristi s Feat!res of Offshore Banking Centers5

A. 'hese units will be %ermitted to set u% in .%ecial (conomic 3ones !.(3". 9. 'hese banks would be virtually foreign branches of the banks but located in India. ). 'hese Overseas #anking 0nits !O#0s" would be exem%ted from 11, .61 and would be given access to .(3 units and .(3 develo%ers finance at international rates. C. 'he O#0s would o%erate and maintain balance sheet only in foreign currency and would not be allowed to deal in Indian 1u%ees exce%t for having a s%ecial 1u%ee account with convertible fund to meet their day to day ex%enses. D. O%erations of the O#0s in ru%ees would be minimal in nature, and any such o%erations in the domestic area would be through the Authorised Eealer. ?. 'he O#0s would be re/uired to maintain se%arate nostro aBc with corres%ondent banks =. Offshore banking accounts can be o%ened & o%erated by Fon$1esident Individuals, or%orates, 'rusts or Offshore om%anies, Indian 1esidents B or%orates eligible to o%en foreign currency accounts under F(<A.

Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking G. On functioning of the O#0s, 1#I would sti%ulate certain licensing conditions such as dealing only in foreign currencies, restrictions on dealing with IF1, access to domestic money market, etc&

'ain A ti7ities 8 F!n tions of Offshore Banking5

A. <ulti urrency Ee%osits Acce%ted. 9. <aturities ranging from AD days to D years. Ee%osits for AD days u%to A month are acce%ted sub+ect to minimum de%osit amount of H A::,:::B$, I ?:,:::B$ & J A::,:::B$. ). Attractive rates of interest on Ee%osits. C. <ulti urrency borrowing o%tion. D. 1ates of interest linked to 6I#O1 of corres%onding %eriod. ?. Full re%atriability of maturity value of de%osits. =. 6oans against de%osit both in foreign currency. G. 8igher rates of interest as com%ared to F F1 de%osits sub+ect to minimum de%osit of H D,::: or its e/uivalent.

Foreign E4 hange an3 9eri7ati7es Transa tions5

A. Katch orders for foreign currency trading for customers. 9. Eerivatives %roducts such as urrency .wa%s, Interest 1ate cash .wa%s, Futures etc. available to hedge loan %ortfolios or cash flow mismatches. ). .tructured derivatives %roducts available.

Internationa% Tra3e Finan e an3 Instr!5ents5

A. ollection of clean or trade bills. 9. Issuance of 6etter of credit, various guarantees. ). #ill discounting or negotiation of documentary collections.

Cre3it Fa i%ities5
A. Finance in all ma+or currencies. 9. .hort termB<edium term working ca%ital or assets finance. ). 6ong tern finance. C. ( #, .yndication of loans or lines of credit. D. .tructured finance.

E%igi:i%ity Criteria5
#anks o%erating in India i.e. %ublic sector, %rivate sector and foreign banks authorised
to deal in foreign exchange are eligible to set u% O#0s.

Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking

.uch banks having overseas branches and ex%erience of running O#0s would be
given %reference. (ach of the eligible banks would be %ermitted to establish only one O#0, which would essentially carry on wholesale banking o%erations.

Capita%:
.ince O#0s would be branches of Indian banks, there is no s%ecial assigned ca%ital
for such branches. 8owever, with a view to enable them to start their o%erations, the %arent bank would be re/uired to %rovide a minimum of HA: million to its O#0.

Reso!r es an3 9ep%oy5ent5

'he sources for raising foreign currency funds would only be through external ways. Funds can also be raised through resident sources. 'hese residents would have s%ecial
%ermission under the existing exchange control regulations to investBmaintain foreign currency accounts abroad. Ee%loyment !0tili,ation" of these funds would be restricted to lending to units that are located in the .(3 and for .(3 develo%ers. Foreign currency re/uirements of cor%orates in the domestic sector can also be met by the O#0s. If funds were lent to residents in the Eomestic 'ariff Area !E'A", existing exchange control regulations would a%%ly to the beneficiaries in E'A.

#r!3entia% Reg!%ations5
All %rudential !Future" norms a%%licable to overseas branches of Indian banks would
a%%ly to the O#0s. 'he O#0s may follow the credit risk management %olicy and ex%osure limits set out by their %arent banks duly a%%roved by their #oards. 'he O#0s would be re/uired to ado%t li/uidity and interest rate risk management %olicies %rescribed by 1#I in res%ect of overseas branches of Indian banks as well as within the overall risk management. 'he banks #oard would be re/uired to set com%rehensive overnight limits for each currency for these branches, which would be se%arate from the o%en %osition limit of the %arent bank.

Anti)'oney La!n3ering 'eas!res5

'he O#0s would be re/uired to scru%ulously !carefully" follow 2Lnow Mour
ustomer !LM "4 and other anti$money laundering instructions issued by 1#I from time to time. Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking

Further, with a view to ensuring that anti$money laundering !money ac/uired

illegally" instructions are strictly com%lied with by the O#0s, they are %rohibited from undertaking cash transactions, and transactions with individuals.

Reg!%ations an3 S!per7ision5

O#0s will be regulated and su%ervised by 1#I through its (xchange
ontrol Ee%artment, Ee%artment of #anking O%erations and Eevelo%ment and Ee%artment of #anking .u%ervision.

Reporting Re;!ire5ents5
O#0s will be re/uired to furnish information relating to their o%erations as are
%rescribed from time to time by 1#I.

#riority Se tor Len3ing5

'he loans and advances of O#0s would not be reckoned as net bank credit for
com%uting %riority sector lending obligations.

9eposit Ins!ran e5
Ee%osits of O#0s will not be covered by de%osit insurance.

Choi e of SE65
O#0. would be %ermitted in .(3s a%%roved by >overnment of India, where
according to >overnment %olicy, O#0s can be set u%.

Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking

RISK 'ANAG'ENTS IN BANKS " ASSET LIABILIT< 'ANAGE'ENT IN BANKS:

1isk has been %resent always in the banking business, but the discussion on managing
the risk has gained %rominence recently. #ankers worldwide have come to reali,e that growing deregulation of local markets and their gradual integration with global markets have dee%ened !absorbed" their anxieties. In banking o%erationsN traditional banking have been shifted to modern banking, where lending & de%osit taking remained the core business of commercial banks, but banks have also started services like derivatives trading, securities underwriting & cor%orate advisory businesses. .ome banks have even ex%anded their traditional credit %roduct lines to include asset securitisation and credit derivatives. Khile other have increased their transaction %rocessing, custodial services or asset management business, in the %ursuit of increased fee income. As a conse/uence of this all factors the issue of risk management has gained new recognition in recent times. 'he im%rovements in I' sector has brought more & more banks to venture in new forms of online electronic banking, where in traditional banking activities have become faster. Additional services such as bill %resentation, %ayment services, etc... have also evolved. 'hese activities mean an increase in the diversity & com%lexity of risks. 'he risks are classified into four categories vi, credit risk, interest rate risk, foreign exchange risk and li/uidity risk.

&a( Cre3it Risk: Out of the four risks credit risk remains the %redominant risk for most banks.
(s%ecially because after the Asian Financial risis, Fon - *erforming 6oans in Indonesia, <alaysia, .outh Lorea and 'hailand roused high to over ): %ercent of total assets of the financial system. 'he costs of dealing with the crisis have been enormous, involving massive transfer of resources. redit risk de%ends on both internal and external factors. 'he external factors are the state of the economy, swings in commodity %rices and e/uity %rices, foreign exchange rates and interest rates, etc. 'he internal factors are deficiencies in loan %olicies and administration of loan %ortfolio which would cover weaknesses in the area of %rudential credit concentration limits, a%%raisal of borrowers financial %osition, excessive de%endence on collaterals Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking and inade/uate risk %ricing, absence of loan review mechanism and %ost sanction surveillance, etc. .uch risks may extend beyond the conventional credit %roducts such as loans and letters of credit and a%%ear in more com%licated, less conventional forms, such as credit derivatives or tranches of securitised assets.

&:( Interest Rate Risk: Interest rate risk arises because banks fix and refix interest rates on their resources
and on the assets in which they are utili,ed at different times. hanges in different rates can significantly im%act the net interest income, de%ending on the extent of mismatch between the times when the interest rates on asset and liability are reset. Any such mismatches in cash flows !fixed assets or liabilities" or re%ricing dates !floating assets or liabilities" ex%ose banks net interest margin to variations.

& ( Foreign E4 hange Risk: 'his risk %ertains to the risks associated with the foreign exchange ex%osures in a
banks balance sheet. 'hese risks are in the form of o%en %osition risk, credit risk, sovereign risks etc. .uch risks arise owing to adverse exchange rate movements, which may affect a banks o%en %osition, either s%ot or forward, or a combination of the two, in any individual foreign currency.

!d" Li;!i3ity Risk5 'he final ma+or category of financial risk is li/uidity risk. 'he li/uidity risk arises
from funding of long$term assets by short$term liabilities or resources, thereby making the liabilities sub+ect to rollover or refinancing risk. 'hose banks that fund their domestic assets with foreign currency de%osits with them may be %articularly susce%tible to li/uidity risk when shar% fluctuations in exchange rates and market turbulence make it difficult to retain sources of financing.

!e" Other Risks5 #eyond the four basic financial risks, banks have a host of other concerns. .ome of
them, like o%erating risk, are a natural outgrowth of their business. #anks em%loy standard risk avoidance techni/ues to mitigate them. In other cases, for instance, where counter - %arty risk is seen as significant, it is evaluated using standard credit risk %rocedures. 6ikewise, most bankers would view legal risks as arising from their credit decisions or from absence of %ro%er %rocedure while finali,ing a financial contract. Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking

'he best way for the banks to %rotect themselves against such risk is to identify the risks, accurately measure and %rice it and maintain a%%ro%riate levels of reserves and ca%ital, in both good and bad times. 8owever, assessing and managing the many facets of risks remains a challenging task for the financial sector. Korldwide, there is an increasing trend towards centralising risk management with integrated treasury management to benefit from information synergies, as well as with economies of scale and easier re%orting to to% management. 'he %rimary res%onsibility of undertaking the risks are that it has to be run by the bank and ensure that such risks are a%%ro%riately addressed & should be vested with the #OEs. At organi,ational level, overall risk management needs to be vested with an inde%endent 1isk <anagement ommittee or (xecutive ommittee of the to% (xecutives entrusted with the res%onsibility of identifying, measuring and monitoring the risk %rofile of the bank that re%orts directly to the #OEs. 'he ommittee should develo% %olicies and %rocedures, verify the models used for %ricing com%lex %roducts and identify newer risks im%acting the banks balance sheet.

In3ian E4perien e5
1#I has issued broad guidelines for risk management systems in banks in AOOO. 'his
has %laced the %rimary res%onsibility of laying down risk %arameters and establishing the risk management and control system on the #OEs of the bank. 8owever, the im%lementation of the integrated risk management could be assigned to a risk management committee or alternately, a committee of to% executives that re%orts to the #oard. 'he risk management guidelines also re/uire banks to constitute a high level credit %olicy committee to deal with issues %ertaining to credit sanction, disbursement and follow$u% %rocedures and to manage and control credit risk for the bank as a whole. 'he 1#I has further advised banks to concurrently set u% an inde%endent credit risk management de%artment to enforce and monitor com%liance of the risk %arameters and %rudential limits set by the #oard or redit *olicy ommittee. 'he %resent sets of guidelines are intended to serve as a benchmark to the banks, which are yet to establish an integrated risk management system. Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

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In addition to the risk management guidelines, the levels of trans%arency & standards
of disclosure have gradually been enhanced i.e. banks are su%%osed to disclose PFotes to Accounts to their balance sheet. 'hese include maturity %attern of loans and advances, maturity %attern of investments in securities, foreign currency assets and liabilities, movements in F*As, maturity %attern of de%osits, maturity %attern of borrowings, and lending to sensitive sectors like ca%ital market and real estate. .uch disclosures and trans%arency %ractices are aimed at im%roving the %rocess of ex%ectation formation by market %layers about bank behaviour and eventually lead to effective decision$making in banks. 'oday, all the banks have their risk management committees, risk committee, Asset 6iability ommittee !A6 O".

Asset Lia:i%ity 'anage5ent &AL'(5

#anks have to address the aforesaid risks in a structured manner by u%grading their
risk management system and ado%ting more com%rehensive A6< %ractices. 'he A6< %ractices are outlined below5 'he ob+ective of A6< is a" to %rovide a strong and dedicated risk management system covering assets, liabilities & balance sheet risks, b" information and scientific risk management techni/ues and c" dedicated asset liability managers or committee. 'he A6< focuses on how various functions of the banks are ade/uately co$ordinated, essentially covering %lanning, directing, controlling, concerned with market risk, interest rate, foreign exchange, etc. 'he A6< is necessary due to market volatility. 'he function of A6< is to sense and minimi,e the risks, mitigation of risks, balance between the %rofitability and li/uidity. One of the risks is the <is <atch maturity risk. 0nder this the A6< tries to have a balanced %ortfolio of assets and liabilities to enable the banks to honour the commitments. 'hese are monitored through the tabling format of assets and liabilities in different buckets such as5 : days - AC days, AD - 9O days, ): days - ) month, ) month - ? months, ? months - Ayear, A year - ) year, ) year - D year, D year & above. 'his table hel%s the to% management to focus on the maturities of the items, which is an im%ortant role for A6< & 1isk management. First, risk management is closely related to A6<. Any mismatch between assets and liabilities increases risks, whether it is interest rate risk, credit risk or li/uidity risk. 'he recent ex%erience of the .outh (ast Asian economies clearly demonstrated the need for having effective risk management techni/ues. Accurate risk identification and classification of %ast losses into ex%ected and unex%ected losses would hel% in %ositioning com%rehensive internal control.

Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2

Off Shore Banking

Le t!re Notes " #rof$ Rah!% Shah &'(: ) *+, +-.-/ 010.2