A Global Vision

The proposal of setting up an offshore banking centre (OBC) in Mumbai has often been discussed in financial circles, but it has never really taken off. The issue was resurrected once again at a seminar held recently by the Confederation of Indian Industry (CII). Says Radha Kannan, spokesperson of the CII: What adds credence to the issue is that the idea was endorsed at the seminar by Manohar Joshi, the Maharashtra chief minister.

The other difference this time around is that a full-fledged committee has already been set up to focus on the the framework of an OBC, unlike as in the case of the Sodhani Committee recommendations. There, the OBC concept jostled for attention alongwith the other recommendations of this committee.

 

Headed by Nimesh Kampani, chief executive officer, J.M. Financial, the committee that has been set up recently will soon submit the working plan to the state government. The positive support from the state government has breathed new life into the proposal of an OBC in Mumbai. In fact, with the prospect of full convertibility very much on the cards within the next few years, the effort is sure to gain momentum.

A competitive edge

A typical definition of offshore banking units states: "Offshore banking is financial intermediation performed primarily for borrowers and depositors who are not residents of the country where the bank is located. Its principal attraction is its freedom from intrusive official regulation." These banks operate in the country of their location. However, they are not allowed to transact in the local currency, which means they cannot operate in the domestic money markets, either.

In spite of these restrictions, there are many reasons that make offshore banking units (OBUs) an attractive proposition. In fact, large multinational banks are interested in setting up offshore banking units (OBUs) mainly because reserve requirements, if any, are very low, and regulation is minimal. There are tax incentives too. Unlike the high rates of tax payable by foreign banks in some countries, OBUs are either zero-tax paying units, or, are subject to very low tax rates. For example, OBUs located in the Cayman Islands and Mauritius do not pay any tax, while those in Singapore pay at a rate of just 10 per cent.

An OBC could be a significant precursor to full convertibility. Full convertibility of the rupee requires deregulated interest rates aligned to the international markets, a well-developed infrastructure including world- class telecommunications, and treasury skills. Since therse units are not subject to the restictions that are imposed upon traditional onshore banks, they could be a conduit for setting such standards in India. Says Girija P.Pande, general manager-ANZ Grindlays Bank: "An OBC is the best interim solution to full convertibility. It will launch India into the global markets in a controlled manner.

The usefulness of an OBU is supported by most financial experts. The Sodhani Committee set up in November 1994 by the RBI, and headed by O P Sodhani, the then executive director of RBI, discussed the possibility of progressive globalisation of the Indian economy.

OBU operations

How would a typical OBU operate? The sources of OBU funds would be deposits or borrowings in foreign currencies from non-residents including foreign entities and other foreign branches of Indian banks. Deposits would also be kept by those residents who are eligible to hold foreign currency accounts. This could well augment foreign exchange reserves.

The funds can be deployed by way of lending to a non-resident, specific category of investment permitted by the RBI, and loans to domestic entities in foreign currency for projects or infrastructure finance under RBI approval.

Ancillary services such as syndication and management of foreign currency raised abroad, financial advisory services, negotiating LCs of non-resident parties, etc. ,could also be undertaken.

A widespread perception--one that the Committee has endorsed-- is that instead of a full fledged centre, OBUs could facilitate the same idea. One reason is that OBUs do not need an earmarked zone. OBUs can be a part of the existing bank branches, though accounting would need to be kept totally segregated from the business of the onshore office. This idea was also stressed by Pradeep K Pain, executive director of TimesBank, and a member of the Sodhani Committee. He says that there should be"complete insulation of offshore accounts in order to allow OBUs to perform efficiently, and strict prevention of any seepage from domestic into offshore accounts."

But this could be just a starting point. Given the benefits of an offshore bank, Mumbai emerges as an ideal choice for setting up an OBC eventually. Says A V Rajawade, noted foreign exchange consultant states that "Mumbai has a time zone advantage since at the beginning of a working day here, traders can participate in the afternoon market in Tokyo, a substantial part of the day in Singapore, the morning session in London, and the opening hours at New York. Pain echoes the same opinion, also pointing out that Mumbai as the financial capital of India has skilled manpower capable of participating in the international currency market.

But how simple is it going to be to set up an OBU or OBC ? Although there are no conceptual complexities, implementation may not be that simple. In fact, there is a great deal of scepticism about implementation. Most agree that infrastructure needs significant improvement before OBC/OBUs can function smoothly. Further, the applicable income tax rates need to beat international rates.

According to Alok Kochhar, vice president, Bank of America:" OBUs may remain an academic issue since the Indian monetary authority is unlikely to permit such deregulation." However, Pradeep Pain is more optimistic and he calls for "macro-level" regulation by the RBI instead of "micro-management".

Concerns!

A major concern is whether the investor base will be willing to assume country risk on India, specially with the increase in political uncertainty.

A few experts have also voiced a concern that OBUs may result in an increase in money laundering. Ramesh Venkat, assistant general manager and head-corporate banking and resources, Credit Lyonnais, says: "OBUs may encourage unaccounted money flows into India." Girija Pandey adds that any risk should not result in scuttling the idea and proverbially "throwing out the baby with the bath water". He calls for a distinction between tax havens and booking centres such as Cayman Islands, Nassau etc., and transactional centres such as Singapore and Hong Kong, which have a more solid business basis and investor base.

Thus, launching an OBC or OBU in Bombay will require upgradation of communication facilities, manpower skills, control mechanisms and changes in the existing fiscal and monetary policies. Further, even though India can move to full capital convertibility without having OBCs or OBUs, there is a strong case for using this concept as a transition phase for moving into full capital convertibility. This is especially because of the fact that it will prepare Indias infrastructure and financial sector for the big leap.

Benefits from OBUs

(a) Increasing the depth and scope of services available to exporters, importers and investors.

(b) Increased investment in world class infrastructure.

(c) Increase in skilled employment. Indian manpower will be suitably trained to operate in the global capital market. This will have a multiplier effect as it will percolate to ancillary industries.

(d) Exposure to international banking for local financial institutions.

(E)Facility to domestic companies that have sold equity abroad to hold their funds in offshore banks here.

The global OBC scenario

Over the past few years, OBCs and OBUs have been mushrooming all over the world.The monetary authority of Singapore set up an OBC and named it the "Asian Dollar Market." Similar attempts have been made in HongKong, Bahrain, Thailand and smaller centres like Mauritius, Nassau etc. A recent report by the Economic Intelligence Unit (EIU) titled Tax Havens and Their Uses(italics) states that offshore financial centres and tax havens are continuing to flourish. Switzerland remains the most successful haven for offshore wealth with one-third of the worlds offshore funds placed with Swiss financial institutions. Caribbean centres such as Bahamas and the Cayman Islands are said to hold 10 per cent of international private assets. According to the International Investor (March 1997), Cayman Islands had 40000 companies registered there, 47 out of the world's top 50 banks, $ 550 billion in deposits and $ 100 billion in regulated offshore mutual fund assets. These are clearly substantial amounts compared to say the $ 11-12 billion inflow of total NRI deposits and $ 8 billion of FII investments into India.

Sodhani Committee recommendations

The Sodhani Committee report has suggested that the OBUs should:

Be free from SLR/CRR requirements

Not be subject to withholding tax on interest paid on deposits raised from non residents.

Have an income tax rate not exceeding 10 per cent

Be exempt from stamp duty.