Offshore Banking and Offshore Currency Trading

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One of the most pervasive features of the commercial banking industry in the 1990s is that banking activities have become globalized as banks have branched out from their home countries into foreign financial centers. In 1960 only eight American banks had branches in foreign countries, but now hundreds have such branches. Similarly, the number of foreign bank offices in the United States has risen steadily.

The term offshore banking is used to describe the business that banks' foreign offices conduct outside of their home countries. Banks may conduct foreign business through any of three types of institution:

1. An agency office located abroad, which arranges loans and transfers funds but does not accept deposits.

2. A subsidiary bank located abroad. A subsidiary of a foreign bank differs from a local bank only in that a foreign bank is the controlling owner. Subsidiaries are subject to the same regulations as local banks but are not subject to the regulations of the parent bank's country.

3. A foreign branch, which is simply an office of the home bank in another country. Branches carry out the same business as local banks and are usually subject to local and home banking regulations. Often, however, branches can take advantage of cross-border regulatory differences.

The growth of offshore currency trading has gone hand in hand with that of offshore banking. An offshore deposit is simply a bank deposit denominated in a currency other than that of the country in which the bank resides—for example, yen deposits in a London bank or dollar deposits in Zurich. Many of the deposits traded in the foreign exchange market are offshore deposits. Offshore currency deposits are usually referred to as Eurocurrencies, something of a misnomer since much Eurocurrency trading occurs in such non-European centers as Singapore and Hong Kong. Dollar deposits located outside the United States are called Eurodollars. Banks that accept deposits denominated in Eurocurrencies (including Eurodollars) are called Eurobanks. The advent of the new European currency, the euro, has made this terminology even more confusing!

One motivation for the rapid growth of offshore banking and currency trading has been the growth of international trade and the increasingly multinational nature of corporate activity. American firms engaged in international trade, for example, require overseas financial services, and American banks have naturally expanded their domestic business with these firms into foreign areas. By offering more rapid clearing of payments and the flexibility and trust established in previous dealings, American banks compete with the foreign banks that could also serve American customers. Eurocurrency trading is another natural outgrowth of expanding world trade in goods and services. British importers of American goods frequently need to hold dollar deposits, for example, and it is natural for banks based in London to woo their business.

World trade growth alone, however, cannot explain the growth of international banking since the 1960s. Several other factors have driven the rapid expansion of international banking beyond what would be required by the growth of world trade. One factor is the banks' desire to escape domestic government regulations on financial activity (and sometimes taxes) by shifting some of their operations abroad and into foreign currencies. A second factor is in part political; the desire by some depositors to hold currencies outside the jurisdictions of the countries that issue them. In recent years, the tendency for countries to open their financial markets to foreigners has allowed international banks to compete globally for new business.

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