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d about 10:00 a.m. (E.S.T.)

Statement
by
Henry C. Wallich
Member, Board of Governors
of the Federal Reserve System
before
Subcommittee on Oversight
Committee on Ways and Means
U.S. House of Representatives

April 25, 1979

Hr. Chairman, I appreciate the opportunity to appear before
this Committee.
As requested in your letter inviting the Federal Reserve
to participate in these hearings, 1 shall discuss the role of
U.S. banks in offshore centers and will comment on the types and
adequacy of the information the Federal Reserve obtains on bank
activities in such locations.
Offshore financial centers, some of which are also tax
havens, are nowadays a highly important part of the international
financial system.

No picture of international financial developments

is complete without taking into account the transactions that are
made or booked in these centers.

It is for this reason that activities

in these centers are of interest to the Federal Reserve as a central
bank when monitoring international flows of money and credit in relation
to domestic monetary conditions.

Furthermore, U.S. banks occupy a prominent

place in these offshore centers.

The Federal Reserve as bank supervisor

must therefore be concerned with monitoring the activities of U.S. banks
in these centers to assure itself that they are conducting their affairs
in a safe and sound manner.
While tax considerations are frequently an important element
in the operations of offshore financial centers

and the kinds of

transactions that take place or are booked in them, they are not
prominent in the concerns of the Federal Reserve about these centers.
Other authorities exercise oversight on tax aspects of transactions




-2in these centers and have the specialized expertise to deal with
such matters.

As I have just indicated, our interests run to the broad

economic implications of activities in these centors and to the bank
supervisory aspects of these activities.

Therefore, in my statement,

I shall discuss, first of all, some general characteristics of offshore
financial centers and of the operations of U.S. banks in them.

I shall

then turn to the role of the Federal Reserve in relation to these
centers to be followed by a description of the kinds of information
obtained by the Federal Reserve in the furtherance of its interests
and responsibilities.

Offshore Financial Centers
Offshore financial centers are easier to identify than to
characterize.

Broadly speaking, however, an offshore financial center

is a location where funds are borrowed from nonresidents and lent to
other nonresidents through the intermediation of banks and other
financial institutions.

These activities are recognized to have little

effect on the domestic economy of the center or on domestic financial
conditions.

Some of these centers are fully operational, in the sense

of actual dealings being conducted with customers regarding obtaining
funds and negotiating credits.

Others are merely booking centers where

deposits and loans are legally lodged, but where no transactions are
physically made.

The City of London is the preeminent example of an

operational offshore financial center.

The Bahamas and the Cayman

Islands, on the other hand, are notable examples of booking centers.




-3What are the essential elements of offshore financial centers
and what has spurred their growth?

As for the former, tax considerations

can of course have an important influence on a country's growth and appeal
as an offshore financial center.

Likewise very important, however, are

factors such as exchange control laws, local reserve requirements,
communication facilities, the country's time zone, its commercial
laws and its political and social stability.

This is illustrated by

the fact that London, the largest "offshore center," is located in
one of the world's most heavily taxed countries.

Secrecy laws are

frequently another important consideration, but, like liberal tax
laws, they are generally more important to the customers of banks
than to the banks themselves.
The growth of offshore financial centers has been prompted
mainly by the needs and demands of multinational business.

As business

has become more and more internationalized, needs for international
financial services have expanded and become more diverse.

Companies

operating in a variety of countries have required funding sources
/

in different currencies, outlets for temporarily idle funds, access
to different kinds of credit facilities, and the means for the transfer
of monies across international frontiers.

Tax laws and foreign exchange

restrictions are, of course, among the crucial factors influencing
the ways international business is transacted.

For multinational

companies, therefore, locations where international financial transactions




-4can be effected free of most tax consequences and of foreign exchange
controls have a great attraction.

Since bankers traditionally follow

their custcmers and adapt to their needs, banks have been quick to
locate in and promote such offshore centers.

U.S. banks in Offshore Centers
U.S. banks have long been located in and played a prominent
role in the major financial centers of the world, such as London,
where "offshore banking" is an important part of their business.
U.S. banks have also played an important part in the development and
rapid growth of offshore financial centers outside the major financial
markets that has occurred in recent years.

As recently as December 1972,

for example, member bank branches in six major offshore centers had
total claims on third parties of only $14 billion, or 20 per cent of
third-party claims at all their foreign branches.

At the end of last

year, those claims totaled more than $95 billion, and represented
46 per cent of third-party claims at all foreign branches of member banks.
The Bahamas and the Cayman Islands are by far the most
important of these offshore centers to U.S. banks.

At the end of

last year, U.S. banks had 139 branches in these two locations with
claims on third-parties exceeding $70 billion.

Details of the

distribution of business among offshore centers and by types of customer
are shown in the accompanying tables.

As noted earlier, the Bahamas

and the Cayman Islands are booking centers for financial transactions




-5that have been negotiated elsewhere.

Virtually all of the branches

of U.S. banks in these centers are consequently "shell" branches—
that is to say, they are a set of ledgers managed and kept by an agent
rather than a physical location where business is transacted.
The growth of international banking is the underlying cause
for the growth of these centers, but the initial catalyst for the
establishment of branches of U.S. banks there was U.S. regulations.
The Voluntary Foreign Credit Restraint Program (VFCR) and the
Interest Equalization Tax (IET), which were implemented in the mid-1960's
to restrict the outflow of capital from the United States, limited the
ability of U.S. banks to meet their customers' foreign needs and to
otherwise engage in international banking.

As a way of doing so,

banks began to establish low-cost "shell" branches in these countries
to obtain access to the Eurocurrency markets.

Since foreign loans

booked and funded in these branches did not affect the U.S. balance
of payments, they were exempt from the restrictions on foreign credits
that applied to domestic banking offices.
Although U.S. Government programs to restrict capital outflows
were ended in 1974, U.S. bank activity in the Bahamas and the Cayman
Islands has continued to grow.

For those banks that do not have full-

service foreign branches in, say, London, these locations offer low-cost
access to the Eurocurrency markets and notably the ability to raise funds
for their international business free of domestic reserve requirements.




-6-

For many bank customers, these locations provide advantages as tax
havens, while for others secrecy laws are important in their decisions
to place funds.
For the banks themselves, operations in the Bahamas and the
Cayman Islands also have certain tax advantages.

U.S. banks operate

abroad mainly through branches, and the earnings of branches are not
deferrable but are immediately subject to U.S. income taxes after allow­
able credits for foreign income taxes paid.

Generally, therefore, where

a foreign tax rate is higher than the U.S. tax rate, there are advantages
to shifting the business from the foreign country to tax-free countries.
Another reason for shifting business into a tax haven country is to enable
banks to avoid double taxation of foreign branch earnings, as can occur
when both foreign and U.S. tax authorities tax the same income.

It should

be noted that in neither of these cases is there an avoidance of U.S. Fed­
eral taxes; in fact, in some instances the shifting of business to tax
haven countries results in greater tax revenues accruing to the United
;
Laces Government.

Income earned in these locations, as with other income

earned abroad, is not subject to U.S. State and local taxation.
The tables attached to this statement provide a general indica­
tion of the types of business booked at branches of U.S. banks in the
Bahamas

and the Cayman Islands.

A large amount of purely interbank

activity is booked in these branches, some of which involves the rechannelling of funds within a bank's organisation and :.cmo of which involves
purely market transactions of buying funds from s-:a banks and selling
..




-7-

them to others.

Loans booked in these branches are preponderantly

to foreign companies, including foreign subsidiaries of U.S. companies,
and totaled $36 billion at the end of last year.

Deposits from nonbank

sources totaled $25 billion, and were divided almost equally between
foreign customers and U.S. addressees.

The latter are primarily

U.S. corporations.

Federal Reserve Role
The Federal Reserve is interested in and monitors activities
of foreign branches of member banks both in its role as the nation's
central bank and its role as a bank supervisor.
somewhat according to these roles.

Our interests differ

In our central banking role, we

monitor activities of foreign offices of U.S. banks in offshore centers
and elsewhere as part of our general surveillance of international
financial markets and international flows of funds.

The growth of inter­

national lending through the Euromarkets and otherwise has had important
repercussions for capital flows throughout the world.

Conditions and

practices in those markets interact closely with conditions and operations
in our domestic monetary and credit markets.

In analyzing the condition

of the U.S. economy and of its external position, as well as in assessing
the consequences of various policy alternatives, much effort at the
Federal Reserve is nowadays invested in following developments in inter­
national banking and financial markets and activities of U.S. banks
in those markets.
As a bank supervisor, our interests are directed to the sound­
ness of operations in these offices and to compliance with relevant banking




-8laws and regulations.

Most of our detailed knowledge of the operations

of U.S. banks in offshore centers arises from our role as a bank supervisor.
Since the branches in the Bahamas and the Cayman Islands are "shell" offices,
virtually all of their records are maintained at the head office in the
United States and thus are available for inspection at the time the bank
is examined.

Indeed, because of the special characteristics of these

branches, the Board, when it authorized them, conditioned its approval
on full records being maintained at the head office.

Another condition

attached to those authorizations was that these offices not be used to
shift deposits and other business from the United States.
The supervisory interest in these operations runs, as I have
already indicated, to their safety and soundness and their possible effects
on the overall condition of the bank.

They are scrutinized by bank examiners

in connection with the overall examination of the bank and in the same
fashion as other parts of the bank.

The emphasis is accordingly on the

quality of assets and the ability of borrowers to repay, in accordance
with the terms and conditions of the credits.

Virtually no attention is

paid to the identity of depositors nor to depositor transactions.

Thus,

customer compliance with the tax laws of their various countries is not
a consideration in the examination process.

That compliance is covered

by other authorities in this country and abroad.

In any event, bank examiners

are basically credit analysts and are not equipped to conduct tax audits.
Information on Offshore Center Operations
The Federal Reserve employs several sources of information on
the activities of offshore

enable it to monitor their com-

/gf ." " V
pliance with sound banking(^¿¿*£lt&syaim relevant U.S. regulations and
that help in evaluating t h e i n t e r n a t i o n a l




financial flows.

-9The information from these sources has been adapted to the Federal
Reserve needs and interests that I have just discussed and are
generally adequate for those purposes.
As I mentioned earlier, our most detailed information
about the activities of U.S. banks in offshore centers is obtained
from examination reports.
document.

These reports are the primary supervisory

In addition, statistical reports are collected periodically

on individual offices that are used mainly in our overall evaluation
of banking activities in these centers.

On a monthly basis, banks

file reports for their major foreign branches showing their assets
and liabilities by type of customer.

Data compiled from this report

(FR 502) are published regularly in the Federal Reserve Bulletin,
including a separate section covering the Bahamas and the Cayman
Islands.

This report is also the source for the data shown in

Tables I and II

attached.

A second report (FR 502S) is collected quarterly and shows
foreign branch assets and liabilities by country.

This report is the

source of the information shown in Tables III and IV attached.
Besides these reports on foreign branches, U.S. banking
organizations also submit financial statements on their foreign
subsidiaries on an annual basis.

Subsidiaries of U.S. banks in the

Bahamas and the Cayman Islands are much less important than their




-10-

branch operations*

At year-eftd 1977, total assets of these subsidiaries

were only $3 billion, about one“third of which represented intercorporate
transactions.

Some of these subsidiaries conduct a wide range of

activities similar to those of branches} others serve mostly to channel
funds among affiliated offices*

While some conduct trust activities,

the volume is relatively small and is directed to foreign parties.

Conclusion
In this statement, I have tried to provide some insight into
the general workings of offshore centers and into the nature of the
Federal Reserve's interest and attention to developments in these
centers, both in general and in particular relation to offices of
U.S. banks.
Attachments




Table I

Assets of Branches of U.S. Banks in Selected Offshore Centers,
by Type of Customer, December 1978
______________ (Amounts in $ Billions)_____________
County

U.S. Parties
(Excluding Parent)

Ndn-U. S Addressees
.
Banks
Nonbanks

Total Claims on
Third Parties

Claims on Parent
and Affiliates

Total
Assets

Bahamas

2.4

26.0

29.7

58.0

14.6

72.6

Cayman Islands
Sub Total

.9
3.3

JLmI
33.7

-5*2
35.5

14.4

72.4

4.0
18.5

JJL.2
90.9

Bahrain

-

2.4

3.9

6.3

3.6

9.9

Hong Kong

-

.6

4.1

4.7

2.0

6.7

Panama

.1

.9

4.4

5.5

2.2

7.7

Singapore

-

3.8

2.5

6.3

5.7

12.0

Total

3.4

41.4

50.4

95.2

32.1

127.1

Totals may not add due- to rounding«




Table II

Liabilities of Branches of U.S. Banks in Selected Offshore Centers,
by Type of Customer, December 1978
(Amounts in $ Billions)

Country

U. S. Addresses
(Excluding Parent)
Banks
Nonbanks

Non-U.S. Addressees
Banks
Nonbanks

Total Liabilities
to Third Parties

Liabilities to
Affiliates

Total
Liabilities

Bahamas

4.8

8.6

17.7

10.3

41.4

31.2

72.6

Cayman Islands
Sub Total

1.5
6.3

3.1
11.7

5.3
23.0

2.7
13.0

12 .6

54.0

5.7
36.9

18.3
90.9

.2

.3

2.7

.8

4.0

f.9
i

9.9

1.2

.7

1.8

4.8

6.7

1.7

1.1

4.0

3.7

7.7

4.2

2 .8

7.0

5.0

12.0

32.8

18.4

70.8

56.3

127.1

Bahrain
Hong Kong
Panama
Singapore
Total

1,1

.1

•1
7.7

12.1

Totals may not add due to rounding.




Table III

Assets of Branches of U.S. Banks in Selected Offshore Centers,
by Location of Obligor, December 1978
_____________ (Amounts In $ Billions)_____________

Country/Region

Bahamas &
Cayman Islands

Europe (Excluding
the U.K.)

14.3

Latin America

23.9

Asia & Middle
East

5.5

3.4

Other (Excluding
U.K. & Off­
shore Centers)

9.3

1 .8

Sub Total

53.0

6.0

3.2

United Kingdom

10.5

.8

.3

Offshore Centers

18.4

2.9

3.2

United States
Parent Banks
Other Parties

9.0
5.8
3.3

.2

90.9

9.9

Total

Totals may not add due to rounding.




Bahrain

Hong Kong

.1

Panama

Singapore

Total

.5

.4

16.1

4.9
2.2

28.8
4.1

15.2

12.6

6.7

4.8

72.7

.9

12.5

1.5

6.2

32.2

.5
.4
.1

.2

5.7

.1
.1

9.8
6.5
3.3

7.7

12.0

127.1

Tab Ip IV

Liabilities of Branches of U.S. Banks in Selected Offshore Centers,
by Location of Lender, December 1978
________________ (Amounts in $ Billions)_______________

Country/Region

Bahamas &
Cayman Islands

Europe (Excluding
the U.K.)

6.3

Latin America

4.8

Asia & Middle
East

5.2

1.7

.1

.1

Other (excluding
U.S. & Off­
shore Centers)

5.2

.4

.2

Sub Total

21.5

2.9

United Kingdom

14.4

Offshore Centers

Bahrain
.8

Kong Kong
.2

Panama
.2

Singapore
.8

.9

Total
8.3
5.7

1.6

8.7

.6

.3

6.7

.5

1.7

2.7

29.3

3.1

2.0

1.2

3.5

24.?

16.0

2.3

3.6

3.0

4.9

29.8

United States
Parent Banks
Other Banks
Nonbanks

39.0
20.8
6.3
11.7

1.6
1.1
.2

.6
.6

1.8
.6

.9

1.1

.1

43.9
23.9
7.7

Total

90.9

9.9

Totals may not add due to rounding.




.8

.1

.3
6.7

7.7

12. 1

12.0

127.1