(Disclaimer: This article only addresses the safety of foreign bank accounts. The reporting requirements and tax ramifications of holding foreign bank accounts are beyond the scope of this article.)
Lately, a number of salesmen from foreign banks have been active in Israel in an effort to convince people to deposit their money with them. Since not all countries maintain the same fiscal policy of keeping interest rates low, the big draw is the high rates of interest in these foreign banks, with above-market returns of 8.5% or more. I feel that these salesmen are misleading the public by claiming these investments are as safe as an ordinary bank cash deposit.
Many of these banks are located in unstable countries and none of them are insured.
I don’t claim that depositing money in these foreign banks is always hazardous, but you do need to understand the risk involved. I have an aunt who lost about $100,000 depositing her money in a supposedly stable bank in Brazil because Brazil historically has offered high interest rates on cash deposits.
I discussed this matter with a foreign bank salesman who responded that his bank is only a two hour plane ride from Israel (implying that the closer you are to your bank, the safer your money will be). I replied that we might as well convince people to deposit their money in an Iranian bank which is much closer and where depositors can earn a 15% return, double what his bank was offering.
Many foreign banks (with the backing of their country’s government), especially those banks located in countries at a stage of early economic development, want to attract foreign investment. They therefore keep interest rates high so that foreign investors can be enticed to deposit their money there and earn higher interest on their money than they can in their own country.
Of course high interest rates also can potentially slow down growth by raising the costs of borrowing, however many smaller and unstable countries have no choice but to pay higher rates in order to access money because investors are otherwise scared to invest there.
Here is a list of questions to ask before depositing your money in a foreign bank:
1) What currency will my cash deposit be denominated in, i.e. what is the foreign currency risk involved?
For example, in Australia, a country with a stable economy, banks pay 4.75% on cash deposits, but deposits need to be made in Australian dollars, not in shekels or US dollars. You would in all likelihood earn the 4.75% return promised by the bank, but your principal and interest would be in Australian dollars. There is currency risk involved. The risk is that Australian dollars might weaken against your own currency at the time you need to convert your Australian dollars back into your own currency, and in that case, it’s possible that you would take a loss.
The bank may allow you to deposit your money in US dollars or British Pounds, for example, but then the bank itself converts your money into a foreign currency prior to lending it out or investing it. You, the depositor, can potentially bear the risk that the bank will take a loss on the currency conversion and pass that risk and loss on to you.
Currency risk itself will not affect you if you elected not to convert your foreign money back into your local money at the maturity of your cd/time deposit. Studies show that the prices of local goods and services in a stable country do not fall nearly as much as the country’s currency falls with respect to other currencies. So in the example given, if you elected to keep or spend your money in Australia as Australian dollars, you would not be substantially affected by currency fluctuations, provided that the Australian economy remains stable.
2) What is the inflation rate of the country where you will be making your foreign deposit?
If a bank in Venezuela is offering 16% per year on a cash deposit and inflation currently stands at 28%, the consumer doesn’t gain much, because his money lost value to a greater degree than his investment grew.
3) Is depositor’s insurance available? This is actually the foremost concern that should be addressed prior to making a foreign currency deposit.
Most countries do not have depositor’s insurance. At the present time, the US government insures deposits of up to $250,000 through the FDIC. Many people are unaware that the FDIC even covers deposits made in the US that are denominated in foreign currencies. Few other countries offer depositors similar protection.
The UK does have depositor’s insurance in place but coverage is not nearly as high as in the US. Many countries do not have depositor’s insurance at all, and the consumer must be wary of the risk that bank insolvency poses to their deposits. Here in Israel, there is no depositor’s insurance, but the Bank of Israel has been known to bail out Israeli banks who go under. Therefore it makes sense that you should be cautious despite the tempting interest rates offered by foreign banks if some sort of depositor’s insurance is unavailable
On a side note, there is a more complicated way to take advantage of the higher yielding deposits available overseas, but you will need the services of a foreign currency specialist or sophisticated money changer to do this. Instead of converting 100% of your money into a foreign currency and depositing all your money overseas, a currency forward contract can be purchased with a percentage of your funds, while the remainder of your funds is deposited in an FDIC insured bank (or SIPC institution). In such an event you would actually earn the same yield as you would have had you invested 100% of your money in an overseas foreign bank that could potentially go out of business while keeping most of your money insured.
Explaining what a forward contract is and how it works is beyond the scope of this article. If you would like to learn more about foreign currency contracts, I advise you to contact a foreign currency specialist or even your local money changer, provided that this money changer deals with forward contracts.
If the bank where you are depositing your money is uninsured, you must not fall into the trap of considering your investment an FDIC insured cash deposit just because you are keeping your money in what appears to be a stable bank. Your capital is at risk. In the event the bank goes under, you can potentially lose some if not all of your hard-earned principal. Depositing money in an uninsured bank is tantamount to buying an uninsured bond. It’s important to understand both the rewards and the risks of these kinds of investments.
Gershon Kayman, Esq. is a seasoned real estate lawyer both in NY and in Israel. He can be reached at email@example.com