Over the past decade we have witnessed a significant increase in the reluctance of U.S.-based banks to provide banking services to offshore based banks such as those based in the Cayman Islands. It’s no secret that many Class B banks in Cayman, many of which tend to be smaller institutions, have faced these challenges due to the new risk-adverse approach taken by U.S. banks.
For some years Class B banks were able to continue their access to the U.S. dollar-clearing system by maintaining correspondent banking services with local Class A/retail banks in Cayman. This is not ideal due to the additional layer of costs, but nonetheless enables them to continue to clear U.S. dollars and offer depository services to their international clients.
But now that solution is fading quickly. Over the past 18 months, many local Class A/retail banks in Cayman have been informing their Class B banking clients that they can no longer offer correspondent banking services where the funds relate to the clients of these Class B banks. The local Class A/retail banks will continue to offer bank accounts to Class B banks but solely for the purpose of handling their local operational expenses.
That latter “benefit” of being able to maintain operational accounts will soon become a moot point as the wider challenge threatens the very existence of the Class B banks. If a bank can no longer accept funds from clients (because it can no longer place those funds at another bank), there is little point in maintaining a banking license.
All stakeholders are apparently aware of this issue, although it’s not clear that the wider economic implications are fully understood.
In 2001 there were 400 Class B banks in Cayman. Today there are 184, representing more than a 50 percent reduction. Just a few years before that, in the 1990s, there were more than 500 of these banks operating in the Cayman Islands.
Much of this decline continues to be explained by mergers and consolidation over the years. There is evidence that this is partly a global trend. But at the same time, there is also clear evidence that institutions still value the benefit of having a Class B license as CIMA [the Cayman Islands Monetary Authority] continues to see applications from interested parties.
Not all Class B banks will be affected in the same manner. Some Class B banks are branches or subsidiaries of existing banks which are either directly based in the U.S. or have access to correspondent relationships in the U.S. But many others will not have access to these solutions.
Class B banks tend to be smaller, but as a subgroup they provide significant employment impact, economic impact and contribution to government revenues in the Cayman Islands. The average bank will pay at least US$100,000 annually in fees comprising their license fees plus others. Anecdotal evidence suggests that each bank likely employs somewhere between two and 10 people and that employment has a further positive economic impact on the Cayman Islands via salary expenditures and local investment.
In addition to the direct economic impact, we also need to consider what this correspondent banking challenge means for the product offering of the Cayman Islands financial services industry. In much the same way that the hedge funds sector has been the key driver of our financial services industry since the late 1990s, the banking product in Cayman has been a key economic force since the 1960s.
Cayman’s reputation as a leading international banking sector continues to be one of the main features of the jurisdiction. But it’s hard to see how it can remain so if there is a dramatic reduction in the number of banks operating from the jurisdiction.
Private banking still has a place not only in the Cayman Islands, but [also] in the global economy, where the rise of family offices and more customized wealth management solutions have come to the fore over the past decade. Class B banks lend themselves to those types of solutions, and some would argue sometimes more so than the often larger and less flexible Class A banks. A jurisdiction that no longer accommodates smaller private banks runs the risk of losing this service offering entirely.
Local policymakers should be looking at solutions which in the short term lessen the burden placed on Class B banks, which need time to find alternative solutions. While a few select Class B banks are being “grandfathered” (allowed to continue maintaining accounts with their local Class A bank), others are simply being turned away. There should be a consistent policy toward all Class B banks with a sufficient/specific time line to seek other solutions or wind down their operations.
Local stakeholders also need to turn their attention to international lobbying. This issue is being driven by U.S.-based correspondent banks, which may in turn be driven by the approach taken by U.S. regulatory bodies toward these banks. U.S.-based policymakers and regulatory authorities need to be educated on the positive role of Cayman-based banks in the wider global banking system and given more confidence in our regulatory oversight of these banks if risk is a concern.
The key question that stakeholders should be asking is not whether Cayman can afford to lose X number of Class B banks at this stage in the wider interest of jurisdictional risk management. It’s a much wider question of whether we can afford to remain complacent in the face of a risk that a similar approach might be taken against any of our other financial institutions in the future. For certain, the new policy of not allowing Class B banks to have correspondent banking accounts has the potential to wipe out an entire industry offering. While some Class B banking clients can transfer over to some of the existing Class A banks, others won’t for a variety of legitimate reasons.
From a policy perspective, to view this Class B banking challenge in the short term as a simple matter of “de-risking” by the U.S. or local retail banks would be a naive approach.
If this challenge to Class B banks is not addressed head on now, what might happen to Class A banks later down the road?
About the author: “Inside Offshore” is an internationally syndicated column on topics relating to international financial services. Paul Byles is managing director of First Regents Bank & Trust. He is also serves as an independent director and consultant to financial services firms. He is a former regulator who has worked in the offshore sector for more than 20 years. He is author of the books “Inside Offshore” and “Introduction to Offshore Financial Services: A BVI text.”