Offshore banking regulation originated as a response to the highly rigid and restrictive nature of domestic banking systems that were in force until early 1990s. There was increasing demand on the liberal and free environment, where restrictions posed by domestic regulatory authorities were not present. This niche was filled by offshore banking regulation present at tax havens that emerged in 1960s. Offshore banking centers provided a competitive alternative to cartelized oligopolistic banking structures that were in place during that period.
Besides permanent critics that is often directed to offshore banking that it is used for money laundering and terrorist
financing experts claim that there are potential risks that offshore banking regulations pose on international financial system. Three of these are more often mentioned. First of all, global financial system becomes increasingly integrated worldwide, volume of global foreign investment also rises, and therefore dependence of domestic financial systems of different countries rises. Due to contagion effect offshore banking system poses a risk for overall stability. If a bank in offshore banking center fails it may spread to other markets and cause banking problems.
Second, due to bank secrecy authorities do not have relevant data necessary for supervision. Absence of such data may result in weak supervision that may end in severe problems for the banking sector.
Third, competitive liberalization in offshore banking centers that is aimed at creating free business environment may result in oversimplification of the offshore banking regulations that poses a potential risk of banking crisis.
The bankruptcy of Bank of Credit and Commerce International (BCCI) triggered adoption of international regulatory/supervisory standards. With Basel Accord it became difficult for a bank with small local demand to spread its activities overseas and this reduced risk of banking problems that could originate from international banks.
Basic principles adopted by Basel Committee are the following:
- International banks are supervised by their home country’s supervisory body;
- The establishment of cross-border banking entities has to be approved by both countries;
- Supervisory authorities from home country should be allowed to collect information on cross-border banking entities;
- In case these principles are not met, host country may impose restrictions on the establishment of banking branches.
In addition to Basel Committee the Financial Action Task Force (FATF) is founded to ensure that the financial sector is free from money laundering, terrorism-financing drug trafficking, and other financial crimes. Local Regional groups were also established.
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