Capital flight has been in the news a lot lately. This has focused attention on those aspects of private international banking, especially secrecy and anonymity, that make it so appealing to banks and customers alike. Two things have accelerated the introduction of regulation in this field. The first is the increasingly public involvement of banks, accountants and lawyers, without whose connivance capital flight from emerging markets could not take place. The second is the realization that it can affect developed countries: for example, German citizens place deposits in Luxembourg to avoid taxes, a practice often encouraged by their domestic bankers.
At first sight, international attempts to impose regulation seem long in gestation. The only comprehensive ban is in money laundering, initiated by the US with the Bank Secrecy Act of 1970 and the Money Laundering Act of 1986, which was followed up by the UN and the Basle Committee two years later. Similarly, the banning of bribery in international business transactions began with the US Foreign Corrupt Practices Act of 1977, preventing US companies from indulging in bribery abroad. But it took the Council of the Organization for Economic Cooperation and Development (OECD) to which all the major money-centre jurisdictions belong until 1994 to follow suit, during which time the US complained, not unreasonably, that its companies had been at a competitive disadvantage.
However, OECD members took just two years to agree to enact legislation that ended tax deductibility of bribes, agreeing as well to criminalize foreign bribery by the end of this year. Progress, while slow at first, accelerated. The same may happen with international regulation of capital flight.
Last year the OECD issued two recommendations aimed at curbing international tax evasion. One advocates tax identification numbers that individuals would need before a bank would accept a deposit. The other relates to international exchange of information. These provide a basis for reporting deposit-taking to a customer’s home country.
Traditionally, countries do not enforce each other’s tax regulations or foreign-exchange rules. In the absence of international agreements, once a customer’s money is outside his home jurisdiction, the authorities are powerless to require its return. However, international deposit-taking banks have to be careful.
“Money-laundering statutes obviously cover proceeds of narcotics trading and also, in the US, proceeds of specified unlawful activity generally,” says David Spencer, a New York lawyer who advises banks on private international banking. “But where the individual is engaged in capital flight, that by itself may be illegal in his home country. For instance, it may be tax evasion or in breach of exchange controls and/or part of a business fraud where he is running two sets of books. So there may be illegality in the home country even if the transaction is not a violation of money-laundering regulations.”
Banks will normally try to protect themselves against this risk by refusing to transfer a customer’s funds from the home country to the country of investment. This way they are able to say that they are simply dealing with funds already outside the home country. However, this can be difficult to maintain where the bank has a local branch in a customer’s home country which, increasingly, money-centre banks do and uses that branch to maintain liaison. Even without a local branch, banks engaged in private banking are increasingly likely to send teams on marketing trips to a customer’s home country to encourage and even facilitate capital flight.
It can be particularly hard to gauge the regulatory attitude of the home government where local banks are themselves offering private international banking. The authorities’ attitude is likely to be that, if capital flight is endemic, local banks may as well benefit since the deposits concerned tend to be substantial and long-term and can be used to fund overseas branches. However, it would be unwise to assume that a relaxed stance by the authorities towards their own banks will translate into similar treatment for foreign interlopers.
In the past, two aspects of private international banking have provided perpetrators of capital flight with the secrecy they require: unreported bank accounts and the absence of any requirement to report transactions to a home country’s tax authorities. Both are set to change.
Bearer accounts have always appealed to deposit-takers. They reduce the transaction costs associated with verification of identity and they remove the risk of liability where such identification is wrong. They can also amount to a permanent free float: in a celebrated Swiss case a bank was able to argue that the beneficiaries of a depositor’s estate could not withdraw the funds because the depositor had failed to give them the password. But anonymous bank accounts are already disappearing. Since 1990, Swiss banks have voluntarily insisted on verification of identity in the case of deposits above a certain level, although when this was adopted they argued that local banking law still prevented them reporting suspected money-laundering transactions.
Some argue that true bank secrecy was lifted in 1977 when a Swiss banking convention required banks to know who the beneficiaries of deposits were. However, the bank could rely on the assertion by an agent (a depositor’s lawyer for instance) that he knew that identity. However, the lawyer could plead professional privilege when pressed to reveal it. More recently, as a condition of European Economic Area (EEA) membership, Switzerland and Liechtenstein agreed to modify their stand on bank secrecy and reporting of money-laundering deposits.
Reporting information to foreign tax authorities is a thornier issue since it affects confidentiality rights. The tax numbers recommendation will require OECD banks to demand depositors’ numbers. Implicit is the notion that transactions will be reported to a depositor’s home tax authority, but it’s not spelt out in the proposal.
However, some OECD members may not agree to it. “The major onshore financial centres have a significant interest in attracting deposits from non-residents by exempting the interest earned from tax and not insisting on reporting details to the home jurisdiction,” says Spencer. They are in competition with non-OECD offshore centres such as the Bahamas and the Cayman Islands. “To be effective globally, and not merely when both the investment country and home country are OECD members, the enforcement system would require the cooperation of financial centres which are OECD and non-OECD members alike,” Spencer adds.
