This article provides a background to the birth of offshore banking units (OBUs) in the Philippines, its operations and the factors affecting the positioning of financial offshore centers. It also discusses the issues confronting OBUs and its effects on domestic banks/banking technology. A short assessment of OBUs future is provided.banking system, offshore banking units, financial center

Sicat, Gerardo P.

English

Research Papers in Economics

II_ Journal of Philippine Development Number Twenty, Volume XI, No. 2, 1984
OFFSHORE BANKING AND THE PHILIPPINE ECONOMY
Gerardo P. 5icat
Offshore banking is better described than defined. With growth
of international banking in the immediately preceding decades, it
became a matter of convenience and expediency for the banks
engaged in international finance to rely on booking centers which
offer the best facilities in terms of cost and other tax advantages.
Regional location also mattered a great deal, Sincespecific geographic
advantages alsoserve particular countries more effectively. Moreover,
theseregions present benefits that relate to the timing of funds place-
ment and generation and contribute to the increase in the efficiency
of the international capital market. With international communica-
tions technology allowing transactions to be made in a matter of
seconds, funds transactionscan be effectively undertaken over differ-
ent time zones during a large part of the 24-hour working cycle for
the world. These factors have contributed to the sophistication of
the businessof banking and have given rise, phenomenally, to what
are known as "offshore" banking centers. As the term implies, off-
shore banks differ from domestic banks. In countries where offshore
banks have been encouraged to be established, those banks are
not allowed to undertake business which is normally reserved to
domestic banking. However, offshore banks are free from interest
rate and other reserve requirement controls that domestic banks are
subject to.
Before 1976, there were no offshore banks in the Philippines.
Therefore, Philippine experience in offshore banking units is limited.
Chairman, Philippine National Bank. This is an expanded version of a paper delivered
before the Fifth Asia-Pacific Foreign Exchange Assembly and the Thai Forex Club on
10 December 1983 at the Royal Orchid Hotel, Bangkok, Thailand. The author received
research assistance from the Department of Research and Statistics of the Philippine
National Bank. He thanks Bienvenido Noriega, Jr., Benjamin Palma-Gil and Valentin
Araneta for conversations and assistance which helped in forming the conclusions of this
paper which, however, are the author's responsibility.
203204 JOURNAL OF PHILIPPINE DEVELOPMENT
But in relation to the modest aspirations in this regard, it seemsthat
the initial targetshave beenfulfilled. This experienceposesanumber
of interesting issues for financial policy-making and therefore areof
unique interest in that respect. In discussing this subject, it isuseful
to review the rationale for the creation of offshore banks in the
Philippines, the benefits derived from them, the future of their
financial operations, and, most important, from a Philippine view-
point, to assess their contributions to the progressof the Philippine
economy. The establishmentof offshore bankshasgivenfurther vent
to new financial issuesconfronting the Philippine policy on banking.
However, the current financial crisi_facing the Philippine economy
posesa threat to the further growth of offshore banksat leastin the
near future.
Backgroundto the Birth of Offshore Banks
The emergence of political independence in 1946 brought. in
central banking and the passageof the commercial banking law in
1949. The Philippine banking sceneasa resultsawthe rapid develop-
ment of banking and the multiplication of domestic banks. The
keystone of commercial banking policy was to reserve domestic
banking to Philippine banks. Further, there was a policy preference
for the development of private banking. Thus, domestic private
banks becamenot only inevitable but were actively promoted.
No foreign banks were allowed to operate in the domestic
economy. ExcePt for the four banks that were already operating in
the country at the time of the adoption of the commercial banking
law, no further foreign branch banking waspermitted. This explains
the preeminent locations of Citibank, Bank of America, the Hong
Kong and ShanghaiBank, and CharteredBank in Philippine commer-
cial banking. These banks had licensesto operate asbranchesin the
Philippines before the enactment of the national commercial banking
act.
Years of development within the financial sector, howevor,
indicated some weaknessesin the progressof the domesticeconomy.
For one thing, while many domestic banks had emergedin the
banking scene,they were undercapitalized. Therefore, the capacity
of these banks to finance a growing economy was limited. In-
adequate exposure to more advanced banking practices.as well as
isolation of contacts with the more dynamic international banks
were surely the result of limited capitalization and the limitedSICAT: OFFSHORE BANKING 205
sphere of market objectives of the private domestic banks. Hence,
these banks tended to be insular in outlook and their full potentials
could not be harnessed.From a national viewpoint, however, it was
essential to make them play a more active role in the finanx:ing of
domestic economic activities.
Following the report of a study group which surveyed the needed
reforms in the financial sector in 1972, the enlargement of the
capital baseof the banking system wasrecommended. To implement
this program, the capitalization of the commercial banks was
required to be raised to a minimum prescribed ceiling. One technique
which was allowed in order to provide for a capital buildup wasthe
liberalization of the participation of foreign interests in the equity
ownership of domestic commercial banks. Such equity ownership
was,however, only up to minority participation of no more than 40
percent of total capital. This program led to the enlargement of the
capital base of the domestic commercial banks and to the entry of
someforeign banks in a minority basisin somePhilippine banks.
Still concerned that the country could not tap the international
financial markets effectively without the participation of the foreign
banks, a thorough study of the option of establishing offshore banks
in the Philippines commenced. An offshore banking system was
perceived to yield benefits to the Philippines by improving the
country's accessto the world's major financial institutions. It would
also provide an invaluable experience in the field of international
finance to the financial community as well as training for young
bankers. This was conceived asan effective vehicle for providing the
transfer of banking technology and practice to the domestic banking
sector through its direct contact with offshore banks. It was further
conceived that offshore banks would assistin facilitating the growth
of Manila into an important satellite among Financial centers in the
region of Southeast Asia and the Pacific. The government was con-
scious of the fact that other cities have grown significantly ascenters
of finance in the region and that there would be room for more
areas,asthere is an element not only of competition in this growth,
but, more important, of complementarity of the various centers not
only in the region but also in the world.
Offshore banks were allowed to be established in the Philippines
in 1976. The law allowing their establishment recognized many
factors that were needed to make offshore banking an attractive
operation in the Philippines. To begin with, policymakers were aware
of the inherent disadvantages of Manila, compared to existing206 JOURNAL OF PHILIPPINE DEVELOPMENT
centers, which had to be overcome to make it marginally more
attractive. This had to be done in the form of certain tax incentives.
There will be more spaceto discusstheseadvantagesand disadvan-
tagesbelow.
The Central Bank prepared the guidelinesfor attracting foreign
banks to establish offshore banks in the country. The offshore
banking law wastimed duringa period when a quantum expansionof
international banking was happening. The Eurodollar market had
beenvery liquid becauseof the largepetrodollarsurplus.In order to
ensure the liquidity of the offshore banking units (henceforth
referred to asOBU's), each OBU was required to maintain at leasta
minimum net fund of US$] million. The incentives structure for
OBU's was so designedand hasevolved over time asto progressively
make the operating environment attractive to them. To ensurethat
Filipinos were trained properly in this new financial activity, the
OBU's werealsorequiredto employ Filipino nationals while allowing
them to employ expartriate personnel. Eventually, and after some
learning process, it was believed that Philippine nationals would
becomeactively engagedin the profession.
As of january 1983, the Philippine Central Bank had already
approved the applications of 28 banks to establishOBU's. Twenty-
six of these are already operating. Among the more prominent of
these institutions are Banque Nationale de Paris, Manufacturers
Hanover, Chemical Bank, Bank of Tokyo, Barclays,Credit Lyonnais,
and ChaseManhattan Bank.
OBU Operations
As with similar systems elsewhere, Philippine-basedoffshore
banks can engage in offshore fund generation and placements in
foreign currency. They may alsodo the samewith eachother and the
Foreign Currency Deposit Units (FCDU's) of Philippine banks and
engage in foreign currency-denominated lendingsto Philippine resi-
dents subject to Central Bank approval. They havealsobeenallowed
to handle the importations of residents with a minimum of US$1
million but to be funded by the sameOBU and to renderfinancial
advisory and related services.The OBU may also trade in foreign
exchangeand discount bills, and invest in foreign securitiesand debt
instruments of nonresidents and other OBU's. There is no limit
placedon their loansto offshore accounts.
OBU's in the Philippines are alsoempowered to handle foreignSICAT: OFFSHORE BANKING 207
exchange remittances, a servicefield that is important to the Philip_
pine economy becauseof the rapidly increasingnumber of Filipino
workers abroad,especially in the Middle East.OBU's are alsooperat-
ing indirectly in the peso lending market becausetheir placements
with domestic bank's FCDU's areconverted by the latter into pesos
for onlending. However, this facility is availableonly on the basisof
currency swapsapproved by the Central Bank for OBU lendingto
onshore accounts. (This facility became an important element in
financing domestic liquidity aswell asin providingthe Central Bank
with external liquidity during the balance of payments crisesin the
Philippines.To the extent that the facility gaveadditional leg room
for maneuvering of the financial position, OBU's have helped in
financing the Philippine economy. An outside critic might argue,
however, that this providedfor an element of instability in the hand-
lingof the Philippine balanceof payments, because,while it stretched
the possibilitiesfor external finance management, it alsobecamea
source of very large short-term instability, once funds even at that
end dried up.)
The OBU's are not allowed to accept local currency deposits,
something which is allowed in two other financial centers in the
region,Hong Kong and Singapore.
FactorsAffecting Positioningof FinancialOffshore Centers
There are several factors that affect the relative positioning
among the financial centers.In relation to the offshore centerslocat-
ed in Singaporeand Hong Kong, Manila isonly a small center and
will probably remain so far many years. There are inherent factors
that help aswell asinhibit itspresentgrowth, andany one institution
that hasset up itsOBU operation in Manila isaware of this.
It may be useful to list a few of these factors which are as
follows: (1) relative cost and tax incentives; (2) infrastructure, in
particular telecommunications;(3) time zone difference; (4) resource
endowmentsand commercial baseof host country; (5) depth of the
financial market; and (6) sovereignriskconsideration.
Of those factors, the Philippinescannot claim advantagein many
of them. in particular, some advantages(for instance,tax incentives
and potential economic and commercial base) are outweighed
perhapsby somedisadvantages (suchasrelatively poortelecommuni-
cationsand lack of financial depth) and, lately, by considerationsof208 JOURNAL OF PHILIPPINE DEVELOPMENT
sovereign risk occasionedby factors that have been associatedwith
the recent financial crisis,
1. Relative cost and tax incentives
Trade-offs between cost of operations and income opportunities
exist for the financial institutions. Manila represents the widest con-
cessions in terms of tax incentives. This is further supplemented by
low housing cost for expatriates and the inexpensive salary levels for
local talent. However, Manila also provides the least number of com-
mercial banking activities possible between the three centers and this
reducesthe opportunity for trading and commercial opportunities.
Tax incentives for Philippine OBU's compare favorably with
those of Hong Kong and Singapore. Income from onshore transac-
tions is taxed at 16.5 percent in Hong Kong basedon net income and
at 40 percent in Singapore while Philippine OBU's pay only a 10 per-
cent withholding tax on grossonshore income.
Income from offshore transactions is not taxed in both Hong
Kong and Manila. in Singapore, the offshore income tax was pre-
viously set at 10 percent but this tax wassuspended recently for five
years with proviso for the possible extension of the tax-exemption
period. This might be a reaction to the competitive nature of the tax
environment, so that it may bedesigned to enhance her (Singapore's)
strong position in the region.
2. Infrastructure, especially telecommunications
Singapore and Hong Kong have telecommunications which are
equal to those in any developed country. In the Philippines, there is
still much to be desired insofar astelecommunications, transport and
utility infrastructure are concerned. Most critical among these is tele-
communications which not only could be costly but, more impor-
tantly, sometimes unrealiable. As bank dealers very well know, cbm-
munications, especially the factor of "speed of access" to it, is one
of the prime ingredients for successfuldealing operations.
3. Time Zone difference
Tokyo virtually starts the trading day as the U.S. West Coast
closes. If Honolulu, Sydney and Melbourne were to bridge the period
between the closing of trading hours in the WestCoast and the open-
ing of trading hours in Tokyo, the world would be literally trading in
foreign exchange around the clock.228 JOURNAL OFPHILIPPINE DEVELOPMENT
TABLE 2
ONSHORE TRANSACTIONS
PHILIPPINE OFFSHORE BANKING SYSTEM
1979-1983
(In Million USDollars)
Loansto Interbenh Growth
Year nonbanh transactions Total rate In
customers per cent
1979 855 1,117 1,972 -
1980 1,231 1,693 2,924 48.3
1981 1,567 1,877 3,444 17.8
1982 1,528 2,048 3,576 3.8
1983 (June) 1,494 1,847 3,341 (13.2)
Total 6,675 8,592 15,257
ONSHORE TRANSACTIONS
PHILIPPINE OFFSHORE BANKING SYSTEM
PER CENT DISTRIBUTION OF TOTAL TRANSACTIONS BETWEEN
LOANS TO NON.BANK CUSTOMERSAND INTERBANK TRANSACTIONS
AND GROWTH RATES
1979.1983
Loans to non.bank Interbank
customers transactions
Year % 5hare Growth rate %Share Growth rate
In per cent In per cent
1979 43.4 - 56.6 -
1980 42.1 44.0 57.9 51.6
1981 45.5 27.3 54.5 10.9
1982 42.7 (2.5) 57.3 9.1
1983 (June) 44.7 (4.4)* 55.3 (19.6)*
Average 43.7 17.4 56.3 22.8
*Annuallzed.
Source ofRawData:Central Bank ofthePhilippines.SlCAT:OFFSHORE BANKING 229
TABLE 3
PROFITABILITY OF PHILIPPINE-BASED OBUs
(In Million USDollars)
I981 1982
OBU Assets /Vetincome Income n_% Assets Net income Income as %
of osse_s of assets
I 109.95 .71 .65% 123.13 .81 .66%
2 270.64 1.53 .56 244.68 1.70 .69
3 303.68 .77 .25 306.76 .56 .18
4 174.54 1.23 .75 144.40 .91 .63
5 704.38 .89 .13 852.36 1.71 .20
6 288.24 .68 .24 240.05 (.93) =
7 83.40 .31 .37 122.64 .26 .21
8 189.02 .07 .04 163.95 33 .20
9 268.47 t .40 .52 282.55 1.62 .57
10 577.19 3.12 .54 427.63 3.52 .82
11 156.24 1.31 .84 156.07 1.02 .65
12 132.55 .55 .41 .121.94 .56 .4-6
13 309.74 .41 .01 316.08 1.26 .40
14 46.35 .39 .13 48.61 .04 .08
15 98.62 .61 .62 112.09 1.03 .92
16 163.23 1.24 .76 174.98 1.27 .73
17 268.74 1.60 .60 380.54 2.48 .65
18 252.83 .89 .35 227.55 .61 .27
19 78.14 .01 .01 108.76 (.13) -
20 161.25 1.54 .96 103.58 1.06 1.02
21 68.66 (.05) - 129.51 .32 .25
22 - - - 305.36 .77 .25
23 - - - 42.46 (.22) -
Source: SEC

Offshore Banking and the Philippine Economy

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Offshore Banking and the Philippine Economy

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