Over the years, I have had dozens upon dozens clients inquire about forming their own bank.
Over the years, the number of banks formed from these inquiries can be counted with the fingers on your two hands.
The biggest misconception seems to be that forming an offshore bank is some end-game solution to asset protection; the ultimate way to keep safe your wealth.
In reality, trusts, foundations, and even companies (LLC, IBC, you name it) typically provide better asset protection. They are also far easier and cheaper to form and maintain.
This post will also go through how offshore banks operate, which might be interesting to anyone who banks or plans to bank offshore.
What is a Bank?
First, we have to understand what a bank is or, more precisely, what a bank can be.
A bank is a company which has been bestowed the rights to accept deposits from someone. A bank may also be licensed to issue credit (loans, credit cards, LOCs, et cetera), although this is not a requirement to be considered a bank. Furthermore, a bank may offer its clients the ability to invest their money; be it that the client does it himself (trading, investing) or the bank does it on behalf of the client (wealth management, private banking).
Most banks in the world are banks you cannot open an account with. These are treasury banks or service banks, whose license do not allow them to take deposits from the public.
The purpose of these banks is instead to act as financial conduits, wealth management for a small group of people, collective saving schemes, and other narrow banking services. Their services may include forms of credit (loans, cards, mortgages) and trade finance. They may also be so-called acquiring banks (merchant banks that open merchant accounts), which have a banking license to settle funds into themselves instead of to other banks.
What most people think of when they get the brilliant idea to form a bank is either a bank to store their own wealth or a bank with a gimmick that supposedly sets it apart from established banks. That’s what we’ll focus on here.
Offshore Banking License Jurisdictions
A lot of FIUs unfortunately do not issue statistics that adequately show the number of offshore banking licenses, but from my experience, the most popular locations for forming offshore banks are the Cayman Islands, Switzerland, and Bahamas. Others worth mentioning are Vanuatu, Anguilla, Malta, Antigua and Barbuda, Cook Islands, and Samoa.
Yes, in theory, The Comoros (Anjouan) and Nauru are also popular, but banking there is impractical. Hundreds of banks have been shut down in those two jurisdictions whenever the governments have decided it’s time to polish on their international reputation for a little bit.
Banking License Requirements
Getting a license comes with a number of requirements. The one given most attention is the capital requirement. This is the amount of money the bank must have in capital reserves at a minimum. This varies depending on type of license, ranging from 30,000 USD to millions of USD. For narrow licenses, where there is no risk to the public but only to members or specific, the capital requirement is the lowest. Licenses that permit taking deposits from the public have the highest capital requirements.
Offshore banks licensed under an International Banking Act (separate from a jurisdiction’s normal, domestic banks) are often exempt from domestic reserve ratio requirements.
The second requirement is physical presence. Your license – even the one that lets you take deposits from the public – may exclude locals in the jurisdiction of your license, but you still need to have a physical presence. In some cases, it’s enough to use a lawyer’s office but more often than not, you need to actually have an office with your own address and staff physically working there.
Third, there is the due diligence on the directors. In order to avoid embarrassments, jurisdictions are interested in ensuring that banks aren’t formed on its territories by terrorists, fraudsters, and so on. This is an extensive procedure which involves submitting proof of identity, proof of income, proof of knowledge of banking, in-depth background checks, interviews, and so on. To cover the jurisdiction’s expenses, an application fee is levied. The fee varies from a few thousand to tens of thousands of dollars.
Running an Offshore Bank
Congratulations! You got your license and you have a few people working in an office in an office park somewhere. You may or may not have relocated yourself, depending on the license requirements and your personal preference. What’s next?
Most customers will expect internet banking, so that might seem like the natural next step. But before that becomes relevant, you need to have a way to send and receive money.
Most will opt for SWIFT membership, applying for a BIC, and open correspondent accounts with other banks. Now, not all banks have correspondent accounts. It is possible can omit correspondent accounts if you go to a central bank for each currency you are interested in and apply for permission to trade in the currency directly. (NB: this is vastly over simplified. Reality is far more complex.) Alternatively, you can decide to only use correspondent accounts for some currencies. However, your bank is too small and too new for this. The compliance requirements may cause too much of an overhead. You have to stick to correspondent accounts.
At this point, you will also need to pen an AML/CFT/ABC (Anti-Money-Laundering/Counter Financing of Terrorism, Anti Corruption and Bribery) policy in accordance with relevant local laws. This needs to cover KYC (Know Your Customer) and its siblings DD (Due Diligence) and EDD (Enhanced Due Diligence). This is why banks ask for copies of your passport, proof of address, and full set of corporate documents. In order to ensure you aren’t sending them fakes, they will ask for certified copies or even certified copies with apostille affixed. Some banks go one step further and require that show up in person to open an account. They can then verify your original passport on the spot as well as get an impression of who you are.
You also need to assess whether potential clients are PEPs – Politically Exposed Persons. FATF defines a PEP as:
- Foreign PEPs: individuals who are or have been entrusted with prominent public functions by a foreign country, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations, important political party officials.
- Domestic PEPs: individuals who are or have been entrusted domestically with prominent public functions, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations, important political party officials.
- International organisation PEPs: persons who are or have been entrusted with a prominent function by an international organisation, refers to members of senior management or individuals who have been entrusted with equivalent functions, i.e. directors, deputy directors and members ofthe board or equivalent functions.
- Family members: individuals who are related to a PEP either directly (consanguinity) or through marriage or similar (civil) forms of partnership.
- Close associates: are individuals who are closely connected to a PEP, either socially or professionally.
The difference between DD and EDD is based on yet another three-letter acronym: RBA; Risk-Based Approach. Depending on how risky a client is, you will need to perform either DD or EDD. DD for a personal account can for example be copy of passport, copy of proof of address, and a reference from another bank. EDD will be the same as DD plus additional documentation, which can include everything imaginable. I know of banks which have asked for grade report, reference letters from embassies, police conduct reports, proof of visa/residence permit, pay slips, reference letter from employer, and so on. In some cases – or rather, in most cases – this comes down to poorly-written and/or poorly-understood internal requirements. But there’s essentially nothing stopping a bank from asking documentation until they are satisfied, or until either party backs away.
It is beyond the scope of this post to describe what makes a customer a certain risk category. If you can’t figure this out yourself, you need to hire experienced compliance staff for your bank. Compliance is where most new banks fail and why most banking licenses are revoked.
So you write your policies, ensure procedures are in place to comply with the policies, and you train your staff. Proving all of this and otherwise satisfying other banks, you open up correspondent accounts in EUR, USD, CAD, AUD, CHF, GBP, SGD, HKD, and any other currency you wish to offer on a 1:1 basis for your customer.
While securing your correspondent accounts, you either purchased a ready-made internet banking platform or build your own. Additionally, you will need to implement an authentication solution. Fascinatingly, some banks to this day still use username and password only for authentication. Two-step authentication is fortunately becoming the norm even among offshore banks, with the emergence of VASCO’s digipass solutions and variations thereof, SMS, access code card, smartphone app code generators, and so on.
When that’s all done, you are ready to start accepting customers. You have probably spent a few million so far and you’re eager to get clients in.
But there are two more things to consider, one of which you should have covered from the very beginning:
- What type of accounts and services you plan to offer.
- Visa and/or MasterCard.
Most small offshore banks just offer current accounts and savings accounts, where the interest is a fraction of what the bank already earns on the money you have placed in their correspondent account. You can expand on this and offer term deposits, where again you only pay a fraction of the actual ROI you’re getting. This is highly profitable, but you are one in a veritable plethora of banks that do the same thing. To set yourself apart, you can offer trading services and investments, either by proxy or by becoming licensed.
Now, what about debit and credit cards. And prepaid cards. Maybe you want to offer anonymous prepaid cards? (Sigh.)
So here’s how it works. In order to issue Visa or MasterCard cards, you need to be licensed to to do, in a process whereby you are assigned your own BIN (or IIN) range(s).
How this works varies across regions, but basically comes down to how much capital you can set aside and secure for your card product. The cheapest to offer are Maestro followed by Visa Electron. Maestro is – supposedly – being phased out by MasterCard and acceptance is limited. Visa Electron is an excellent choice, but also have limitations. It’s not necessarily that your cards have limitations, but Maestro and Visa Electron may have limitations where your customers are from and, as such, may be viewed negatively.
What you really want is Visa and MasterCard, plain and simple. These are the cards that will be attractive to your customers. You will need both corporate cards and personal cards, which each require their own BIN. If you qualify for it and you want it, you can license more privileged card types, such as Gold, Platinum, Infinite, World, Blue, and so on. What’s available depends on region, although Visa is generally the same world-wide.
In this process, you can also apply for prepaid cards, if you want to offer those as well. They are subject to higher scrutiny than personalized cards.
Note that in order to issue credit cards, you will likely need a banking license which permits you to issue loans.
Once you are issuing your own cards, you need to hire a few more people to look after the card product and handle disputes (chargebacks), PIN code changes, lost cards, clearing refunds, removing voided payments, and so on.
You might want to partner up with for example airlines or airline alliances to offer value-added services to your card, but this of course also come with capital and regulatory requirement.
An alternative to this whole process is to use a third-party issuer and piggyback on one of their BINs. It won’t look as professional and tends to be very expensive in the long run.
Alternative card schemes (American Express, JCB, China UnionPay, et cetera) are not worth your time unless you are a local bank in a country where JCB or China UnionPay are big.
This post is getting way too long. A lot can be said about forming and running an offshore banks. Chances are you probably can’t afford it, wouldn’t pass the background checks, or have the know-how to pull it off.
However, if you do – best of luck out there! Do it right and it’s going to be one of the most exciting, stressful, and rewarding experiences of your life.