How International Banking Works

There’s a wealth of reasons for individuals and companies to bank internationally. Many people around the world use international banks to shelter their money from their home country's income and estate taxes. Hosts of banks are based in countries with low or no income and estate taxes, such as the Cayman Islands, Belize, Panama and the Isle of Man. But you can't just put your income in Belize and not pay taxes. Customers must report their income and work with their bank to make sure tax avoidance doesn't turn into tax evasion.

Some individuals use international banks to invest in the economies of booming countries and in developing countries, the same way they might invest in a domestic corporation or real estate venture.

A number of wealthy individuals keep their wealth in offshore banks and other entities to keep it safe from lawsuits. That doesn't mean these people are criminals; they simply want to avoid losing every penny to a sudden, unexpected or predatory lawsuit.

Since international banks lend and borrow on international markets, they’re less affected by domestic interest rate fluctuations. For example, when Mr. and Mrs. Platinum want to avoid sinking interest rates in their own country, one thing they might do is move their money into an international bank.

Also, some foreign banks might offer better interest rates than domestic banks, providing a money-making opportunity for customers.

International banks also make it easier for a company with an international presence to do business around the world.

For one, the company doesn't have to set up a million different bank accounts around the world, then wait to receive money while the banks deal with one another.

In addition, international banks offer many financial services to facilitate international trade. Besides offering payroll services for companies with employees and contractors in other countries, they offer letters of credit to ensure that companies in different countries pay one another for goods and services. They also offer financing services to support businesses facing the large costs of importing and exporting products.

The process of establishing an account at a reputable international bank will probably include the following:

Next we'll take a look at the hazards of international banking.

There are some hazards in international banking:

Is the bank in a country on the verge of civil war or economic collapse? Is the bank in a country notorious for its corruption? Keep your money away from fire.

Is the bank known for efficiency and smart investments or for poor customer service and federal bailouts? Again, do your homework.

Just as domestic currency can change value, so can foreign currency. If you invest your money in a foreign bank, and then the value of the foreign currency plummets, you lose money. Furthermore, if you make a bunch of money through an international investment, your profit may be greatly reduced when you convert the money to your less-than-booming home currency.

To address this issue, many international banks encourage account-holders to keep their money in interest-bearing accounts and other investments. Customers can use the money they earn on such accounts to conduct business abroad. When the currency exchange rate improves, the customer can bring some money home to the Missus or Mister.

The Federal Deposit Insurance Corporation (FDIC) does not insure foreign banks, though it can insure U.S. divisions of foreign-based banks. If you're planning on banking internationally, inquire about depositor insurance provided by the bank's home government or other entity.

Because of rising international concern about money laundering, terrorism and tax evasion, many international banks will keep an eye on your account activity. If you're moving massive amounts of money around quickly, you will raise a red flag. Criminals and terrorists love to launder money through international banks, passing their questionable funds through foreign accounts, many of them anonymously held, until the legal trail is lost.

Tax evaders often use international banks to set up companies and trusts whose sole purpose is to hide money and erase its relationship to the owner. If a tax collector, such as the Internal Revenue Service, can't prove you own the money, it can't collect taxes on it. If these companies and trusts aren’t legitimate money-making entities, you’re participating in an abusive tax shelter (by U.S. law, at least). The IRS charges very stiff penalties for participating in abusive shelters. In the settlement offered by the IRS in the Son of Boss abusive tax shelter, participants paid penalties of as much as 20 percent of their unpaid tax on top of their outstanding tax liability [source: IRS].

Be careful with the offshore banks you do business with -- don't be collateral damage in the wars against tax evasion, money laundering and terrorism.

If you'd like to know more about international banking and related topics, you can follow the links on the next page.