The whole offshore industry traces its roots from the times when the Channel Islands were granted their tax-free status under the jurisdiction of Great Britain to facilitate further economic growth and development of this remote colony. Ever since then numerous countries with relatively small national budgets yet stable political situation started declaring their offshore statuses to attract foreign investors and depositors.
By definition, an offshore bank is a bank located outside the country of residence of the depositor, typically in a low tax jurisdiction that provides financial and legal advantages. This primarily deals with strong privacy, less restrictive legal regulation, low or no taxation, easy access to deposits, and protection against local political or financial instability.
One common misconception is that offshore banking can legally prevent assets from being subject to personal income tax on interest. Except for certain persons who meet fairly complex requirements, this is incorrect as the personal income tax of most countries makes no distinction between interest earned in local banks and those earned abroad. Persons subject to US income tax, for example, are required to declare on penalty of perjury, any offshore bank accounts they may have. Although offshore banks sometimes do not report income to other tax authorities this does not make the non-declaration of the income or the evasion of the tax on that income legal in most jurisdictions.
Quite a few things have to be mentioned in terms of the advantages of offshore banking. First of all, offshore banks provide access to politically and economically stable jurisdictions. This may be an advantage for those resident in areas where there is a risk of expropriation or where there is corruption within the banking system, or bank officers may become liable to the influence of or pressure from criminal gangs. Secondly, some offshore banks may operate with a lower cost base and can provide higher interest rates than the home country due to offshore finance being one of the few industries that geographically remote island nations can competitively engage in. Interest is generally paid by offshore banks without the deduction of tax. This is an advantage to individuals who do not pay tax on worldwide income, or who do not pay tax until the tax return is agreed, or who feel that they can successfully evade tax by hiding the interest income (which, however, is not to be recommended). In addition, some offshore banks offer banking services that may not be available in one's country of residence. One such example is paperless bank statements. Finally, offshore banks in some countries (by law) participate in mandated bank account deposit protection insurance systems. A US person using a bank in Australia, NZ, Canada (or any EU country) would get similar deposit protection as using a US bank.
Speaking of the disadvantages of offshore finance, it is worth mentioning that few offshore jurisdictions have depositor compensation schemes, to bail out depositors in the event that a bank becomes insolvent. For years, offshore banking has been associated with money laundering and organized crime. There is a risk of reputation being tarnished by association. In addition, the advantages of offshore banking may come at a high cost as the returns on some offshore banking accounts may be substantially below those of normal bank accounts. Also, the fees and minimum deposits required to open and operate accounts at some offshore banks can make them inaccessible to the general public. Prospective clients should also keep in mind that offshore jurisdictions are often remote so physical access and access to information can be difficult – besides that, there is a wide range of scams offering offshore accounts at low cost.
It is quite possible to obtain the full spectrum of financial services from offshore banks (including Deposit Taking, Credit, Money Transmissions, Foreign Exchange, Letters of credit and trade finance, Investment Custody, Investment Management, Fund Management, Trustee Services, Corporate Administration etc). Nonetheless, not every offshore bank provides each service. Banks tend to polarize between retail services and private banking services. Retail services tend to be low cost and undifferentiated, whereas private banking services tend to bring a personalized suite of services to the client.
In the 21st century, the majority of offshore banks operate within highly regulated environments. The quality of the regulation in monitored by supra-national bodies such as the IMF. Banks are generally required to maintain capital adequacy in accordance with international standards. They must report at least quarterly to the regulator on the current state of the business.
Whilst offshore banking has a historic association with organized crime, it is an important part of the international financial system. For example, the Cayman Islands is the fifth largest banking center globally, in terms of deposits.