BUSINESS OFFSHORE BANKING

THE CAYMAN ISLANDS, the Bahamas -the names evoke images of island paradises, laden with sun-drenched vacationers and cash-rich banks.

And in truth, tourists in search of suntans and businessmen in search of banking privacy flock to the Caribbean and West Indies. But those with a few million dollars lying fallow, and who are not especially attracted to the surf, can save their air fare.

Instead of lugging all that money offshore, four of Dallas’ largest banks have brought a piece of the Cayman action home to Texas. Through their Cayman or Nassau “branches,” banks such as Mercantile National Bank at Dallas and InterFirst offer some of their preferred customers banking privacy, attractive interest rates and tax advantages.

The unusual thing about these branches, though, is that they are located in Dallas, not on a Caribbean or West Indian island. They are, in the words of one banker, paper branches, or shell operations, existing only as a set of books.

Federal banking regulators, while not enamored of these offshore branches, say they are legal, quite common and useful. Fourteen Texas banks, located primarily in Dallas, Houston and Fort Worth, have Cayman or Nassau branches, according to federal Comptroller of the Currency records in Washington, D.C. And 134 banks nationwide have such branches.

Banking executives say there is considerable misunderstanding about what offshore banking is and what it’s not. The most erroneous assumption held by the public, they say, is that offshore branches are used to funnel illicit profits out of the United States.

Indisputably, tax dodgers and narcotics traffickers try to hide and launder money in Caribbean banks. But U.S. banking regulators say that only a small percentage of the Cayman and Bahamian transactions are unscrupulous or illegal.

“The Caymans are an international banking and financial center; there are billions of dollars in transactions made through the Caymans and 99.9 percent of the transactions are legitimate,” says Charles Morley, chief investigator for the U.S. Senate subcommittee on investigations.

The public’s perception that the Caymans are awash in cash from drug profiteers is erroneous, Morley says. His subcommittee will soon release a report about the increase in the use of offshore branches set up through American banks.

James B. Gardner, president of Mercantile at Dallas, says his bank has offered offshore banking to its customers through its Cayman branch since the mid-Seventies. Although the branch is licensed by the Cayman government and must abide by that country’s banking laws, money deposited in the branch never leaves the United States, he says.

The money is “booked” through the Caymans, but it’s not physically transferred there. As Gardner says, “It’s important to note that there is nothing down there in the Caymans in the way of the cash deposited with us. If the Cayman government decided to seize our deposits, well, there is nothing for them to seize in the Caymans.”

The branch exists on paper only; it’s simply a set of books maintained outside the United States that technically qualifies it as a foreign branch, says Gardner.

“What you do is you have someone, typically another bank, act as your agent in the Caymans, and they simply keep your license in a file, keep a set of books and on some door there is a long list of banks which have branches,” Gardner says. “Every month we mail our agent (Bank of Nova Scotia) a duplicate of our ledger, which shows the transactions for that month. This shows that there really is something going on down there. But basically, a foreign branch is nothing but a bank account.”

The Cayman government doesn’t tax money deposited through one of its branches, which makes the island nation one of the most popular for setting up offshore accounts, Gardner says.

“If you have someone who wants to deposit money in your foreign branch, he can actually come here to the Mercantile bank in Dallas to deposit it, but the money will technically flow through the foreign branch.”

The Bank of Nova Scotia acts as Mercan-tile’s agent in the Caymans for a yearly fee of $1,000. The original charter for the branch, which was issued by the Cayman government, cost the bank $10,000, Gardner says. This is much cheaper than operating an actual branch in the Caymans with outlays for salaries and a building. This is the reason most large U.S. banks open unmanned branches in the Caymans.

James C. Monroe Jr., a senior vice-president at Mercantile, says that “fewer than a hundred” of his bank’s customers use the Cayman account, and all of them are mid-to large-sized companies.

“I would say our average deposit is $10 million in the Cayman branch. More companies could benefit from the account, but the psychology of corporate officers is to invest in only the safest securities. The Cayman account is an unknown. Many people wonder where the Caymans are. We tell those we get a chance to talk to that the money never leaves the United States,” Monroe says.

Although the average depositor has not even heard about offshore banking, deposits booked through offshore branches of Dallas banks are substantial. Last year, Mercantile booked $760 million, or 8.5 percent of its $9.01 billion in total deposits, through its Cayman branch, according to Gardner.

RepublicBank Dallas has $1.4 billion on deposit in its Nassau branch, or about 14 percent of its total deposits, according to its year-end report. Similar figures were not available from the other two Dallas banks which operate offshore branches-InterFirst Dallas and Bane Texas Dallas.

Central to the understanding of offshore banking is a grasp of the terms “Eurodollar” and “Eurodollar market.” Banks open offshore branches primarily to tap into the so-called Eurodollar market, bank analysts say. And the increase in the number of banks offering foreign branches is parallel to the growth of the Eurodollar market, which is estimated conservatively at $1.5 billion.

Eurodollars are U.S. currency that accumulated primarily in Europe following World War II. The rebuilding of war-torn Germany, oil importation and trade deficits produced a vast pool of American dollars overseas. Dr. Robert Strand, an assistant professor of finance at North Texas State University in Denton, explains that as America began to dominate world demand, foreign banks began accepting U.S. dollar deposits and making loans in dollars as well.

Bankers in London were the first to take dollar deposits, he says, and today the interest rate quoted on Eurodollars is often referred to as the London Interbank Offered Rate (LIBOR for short).

The mostly unregulated Eurodollar market has expanded from about $500 million in the mid-Seventies to its current $1 trillion-plus level, banking experts say. Some economists have written that it’s futile for the Federal Reserve Board to try to regulate domestic money supply when there is more than $1 trillion floating around in banks and branches outside U.S. government control.

But this lack of federal control is precisely what makes transactions in Eurodollars so attractive to bankers, borrowers and depositors. Money deposited in RepublicBank’s Nassau branch, for instance, is not subject to Federal Reserve requirements. Thus, a bank that receives a $100,000 deposit may, if it chooses, loan that entire amount, holding nothing in reserve.

If that same deposit were put into a domestic certificate of deposit, the bank would be required to place at least 3 percent ($3,000) of the deposit in a non-interest-bearing reserve account. Reserve requirements range from 3 percent to 12 percent, depending on the type of deposit. (It should be noted that the Federal Reserve does require that some part of a deposit be held in reserve if it’s loaned to a domestic customer, rather than to a foreign subsidiary. Because of that restriction, most banking executives say they will not fund domestic loans with Eurodollar deposits.)

“If the bank has to set aside a portion of its deposits in a non-interest-bearing reserve, then that’s a cost it has to absorb,” Gardner says. “You’re not earning any interest. So, obviously, if you’re going to compete for deposits with bankers from outside the country, you have to have a foreign branch, since they aren’t subject to reserves and you are.”

Without reserve constraints, a bank, through its offshore branch, can offer a higher interest rate on deposits and a lower rate on loans. Currently, a six- month CD pays 11.5 percent interest, compared to 11.75 percent for a Eurodollar deposit.

John Falb, executive vice president of Re-publicBank, says: “We use our Nassau branch to fund overseas operations, not domestically.” RepublicBank opened its Nassau branch about 12 years ago. “We do all the bookkeeping in here [RepublicBank]. In Nassau, we have a room a little larger than a closet, and I believe there is a Telex machine, and then we have our designated representative who works for us. What’s great about the Bahamas is that the banking system is so free.”

The Cayman Islands, about 100 miles south of Cuba, is a tri-island country of 17,000 residents, and more than 600 banks. It’s a British colony but is unfettered by the high British taxes and rigid banking controls. The banking privacy afforded the banks of Grand Cayman, Little Cayman and Cayman Brac is unmatched in the world, banking experts say.

A Cayman banking official can be jailed for even divulging that someone has an account in a Cayman branch. In addition to the stringent privacy practices, the country offers some of the most liberal tax advantages in the world. Cayman residents are not required to pay taxes on income, inheritance or capital gains. And, Cayman residents pay only $10 per year in personal taxes.

More than two dozen of the world’s largest banks are represented in the Cayman Islands and the government’s attitude toward foreign investment is receptive, bankers report. The stable government, liberal tax laws and the minimum amount of bureaucratic entanglements involved in setting up a Cayman branch are all given as reasons why U.S. banks set up their foreign branches on these tiny islands.

Banking executives say they would like to make the offshore accounts available to small depositors, but the Federal Reserve “strongly encourages” them, as one banker puts it, to only use the branches to finance international trade and to fund overseas operations.

Most Dallas bankers say they require customers to deposit a minimum of $100,000, if they want to use the Cayman branch. As Strand of NTSU says: “This is the big boy’s market.”

These deposits aren’t insured by the Federal Deposit Insurance Corp., which is another reason banks pay a higher interest on Euro-deposits, says James A. Brickley, chairman of assets and liabilities at Inter-First. With more risk comes a higher interest rate for customers, he said.

“There is a fundamental risk involved, since you are making a deposit in a foreign branch. Whether the U.S. courts would ever freeze assets in a foreign branch is a legal question; it is generally held [by bankers] that they would not,” Brickley says.

Other bankers agree, saying that the likelihood of the Cayman government freezing desposits booked through one of its branches is so remote that it’s of little concern.

Joe Fitzgerald, a national bank examiner for the federal Comptroller of the Currency, says that more than $180 billion is being held on deposit by U.S. banks in their offshore branches. Interest in Cayman branches “increased tremendously during the Seventies because of the OPEC situation,” he says.

“They quadrupled the price of oil, and suddenly the OPEC nations were awash with funds; Eurodollar deposits then became very popular. They are not a major corporate and banking market,” Fitzgerald says.

Although, the Federal Reserve would discourage a depositor from speculating in Eurodollars, it can’t control the activity, he says. Federal Reserve spokesman, W. Arthur Tribble says speculation in Euro-currencies has been a part of the banking scene for the last 15 years. The huge influx of American dollars into the Euro-market has begun to “fuzz things up a little” as far as the FED’s ability to regulate money supply. More than $20 billion, for example, in Eurodollars flows in and out of New York City each day, says one banking regulator.

Dallas bankers say that their typical customers are multinational corporations that have foreign subsidiaries.

Says one bank executive, who asked to remain anonymous: “We have to know our customers. If you come in off the street with a bag full of money, we’re not going to let you put that in our Cayman branch.”

One large source of Eurodollar deposits comes from the profits of the foreign subsidiaries of American companies, Gardner says. Profits earned by American companies with overseas operations are subject to federal taxation if they’re brought back to the United States and deposited in a U.S. bank. But if those same dollars are held in a Cayman or Nassau branch of a Dallas bank, the IRS has no tax claim until they are deposited in a domestic bank account, he said.

“You don’t have to pay U.S. income taxes on these earnings until they are repatriated to the U.S.,” Gardner says.

Officials of Mary Kay Cosmetics Inc., who say they are very conservative investors, occasionally will deposit idle cash in offshore branches of Dallas banks. Larry Cox, corporate treasurer for Dallas-based Mary Kay, says most of their Euro-deposits mature in 30 days on the expectation that losses would be minimal if interest rates began to drop precipitously.

“The yield on Euro-time deposits is a bit higher than regular CDs,” Cox says. “That’s the No. 1 reason why we invest in Eurodollars. Normally, we try to book our deposits through London, and we don’t go out for more than 30 days. We don’t want to take a risk on the principal, and the dollars don’t make their way to London or the Caymans.”

The amount of privacy afforded a Cayman or Nassau branch transaction is a matter of some dispute. Most banking executives contacted say that despite the Caymans’ banking privacy laws, the banks would readily turn over individual banking records to the IRS or police agencies, if those agencies subpoenaed them. Thus, they say, it’s senseless for anyone to deposit money in their offshore branches on the belief that the transaction is beyond scrutiny.

But one Federal Reserve official says the United States has no legal jurisdiction over Cayman banking records, and a bank probably could avoid making those records available. And a U.S. Customs officer in Houston says his office has attempted to subpoena Cayman records from an American bank and was told that the bank did not have the authority to turn over those records.

In response to the outpouring of American dollars into the uncontrolled Eurodollar market, U.S. banking laws were amended in early 1981 to allow for “International Banking Facility” accounts. An IBF, as it’s called, is similar to a Cayman account, but with one major exception: Domestic customers are forbidden by the Federal Reserve from using the account. The intent of the IBFs was to attract foreign, not domestic, depositors, Gardner says.

Hailed in 1981 as the solution to bringing the flow of U.S. dollars back under the control of the Federal Reserve, IBFs, says Gardner, “have become a non-event.” Says one banker, “Some people just want to keep their money in a Cayman account.”