The Tentative Re-launch of Offshore Banking Services

There are four main positive aspects of the development of OBS. First, banks qualified to launch the OBS will be exempt from allocating reserves to the PBOC for OBS deposits. This will significantly decrease the banks' financing costs. Second, foreign exchange involved in the OBS process will not be scrutinized by the SAFE and can move freely overseas from China. Third, the OBS market will boost the competitiveness of domestic banks. Thus far, only PRC banks and their branches can initiate the OBS. Finally, banks may exploit the new opportunities to generate profits, in addition to the traditional financial services rendered to customers. Especially, banks can work to maximize profits from the gap between the lending and borrowing interest rates.

The Cons

Still, there are some significant problems with the launch of the OBS. For one, business scope is still restricted and is limited to foreign exchange deposits, customer lending, inter-bank short-term lending, international clearing, offering of large-amount transferable deposit certificates, offering guarantees against foreign exchange, consultation and other services permitted by the SAFE. Also, most of these services are simultaneously subject to other regulations or special requirements and qualifications.

A second problem is that the qualification requirements are tough. By implication, only those major banks with sound internal operations and risk evaluation and precaution mechanisms are entitled to engage in OBS operations. In addition, applications will be closely scrutinized by the regulatory authorities, including interview procedures.

A third major obstacle is that a participating bank is only permitted to manage an OBS for its own sake; the regulatory authorities strictly forbid banks from being agents of other institutions. This provision aims to prevent institutions from circumventing the OBS requirements without gaining the corresponding approval. The underlying theory is that an agency service may be rendered without the risks involved; this would be attractive, but the benefits of the OBS are not available from the very beginning for agencies.

Outstanding Issues

Tax Rates

Taxation is among the most often-discussed factors in financial services. But a favoured tax rate is not granted to institutions operating the OBS. This isn't likely to sit well with prospective participants. Abolishing taxes on interest profits should be done to attract foreign investors.

National Treatment

As noted above, only Chinese banks are permitted to operate OBS. Still, the PRC Administration of Foreign-funded Financial Institutions Regulations prescribes that the opening of this business to foreign banks is permissible with the PBOC's approval. This discrepancy in the law will obviously undermine the confidence of major international financial institutions.

Loopholes in the Definition

As stated in the PBOC's Administration of Offshore Banking Procedures (October 23 1997), the OBS should only be rendered to foreign parties. Nonetheless, implementing rules for these regulations issued on May 13 1998 stated in Article 3 and Article 4 that domestic institutions are allowed to borrow money from offshore banks as international commercial loans. Superficially it appears that the authorities would like the OBS to work with onshore clients. But this contradiction probably will lead the offshore banks to be confused on the definition of the OBS as well as their service objectives. To avoid this, the definition of the OBS in the regulations should be modified accordingly, with the isolation of the OBS from its domestic counterpart being the preferable solution.

Interest Rate Discrepancies

The flexibility enjoyed by the OBS is that interest rates may be determined in response to the market, similar to other international banking practices such as LIBOR. However, domestic interest rates are rigidly maintained by the PBOC. The discrepancy between the international and domestic markets may result in a capital flight as domestic foreign exchange deposits seek more profitable rates overseas.

Separation from Onshore Businesses

The accounts report, balance sheet and income statement in respect of the OBS must be provided separately from any onshore business sectors that the banks may have. This is intended to make intentional concealment of losses and other improper behaviour by a consolidated balance sheet or other methods impossible. Poorly performing offshore banks will thus face official scrutiny and can lose approval to operate an OBS.

To date, the OBS industry is still in its initial stages. But the business is bound to grow, especially given the background of the further opening of China's financial markets, strengthening of the supervisory system and the economic development of China.

By Anthony Qiao

Zhong Lun Law Firm, Shanghai