Bank capital is at risk of fleeing the country and Florida should the feds adopt an IRS rule requiring banks to report interest earned by foreigners, who fear reprisals from their home countries.
What. IRS wants banks to report interest paid to foreigners.
Issue. Proposed rule might drive capital offshore
Impact. Withdrawal of deposits limits lending capacity.
Florida banks' future ability to extend credit may be significantly hampered by a proposed Internal Revenue Service rule requiring U.S. banks to report interest earned on deposits of individuals from any foreign country, so-called nonresident aliens.
That's the position of Florida's entire congressional delegation, the state's Office of Financial Regulation, the chairman of the state senate's Banking and Insurance Committee, the American Bankers Association, and the Florida Bankers Association and its President and CEO Alex Sanchez. With the potential for as much as $15 billion in capital fleeing offshore from Florida by one estimate, it's very much on Sanchez's radar. He testified against the proposed rule in Washington, D.C. recently.
The new rule may be finalized this year, but might not go into effect until 2013. With it in place, the IRS hopes to improve its cooperation with other countries so information won't be limited by bank secrecy or the absence of a tax liability. The IRS also looks to cut down on false claims of foreign status by U.S. residents.
Florida banks receive billions of dollars of foreign deposits, money that banks use to make loans to Florida businesses and consumers. The state's banks attract those deposits because of Florida's proximity to Central and South America and the “distrust of foreign economies and their governments by their citizens,” wrote Thomas Cardwell, Florida's commissioner of the Office of Financial Regulation, in a five-page letter to the IRS dated March 31.
In the letter, Cardwell points out that there are more than 70 financial institutions in south Florida alone with deposits in so-called nonresident alien (NRA) accounts. “Some have over 50% and some as much as 90% of their deposits in NRA accounts,” he writes. “If there are substantial withdrawals of these funds in a relatively short period of time there will likely be liquidity issues that could cause the financial institutions to fail.”
Cardwell also expresses concern with the timing of the rule. “This is the moment when Florida most needs to prime the lending pump particularly to small businesses,” he writes. “The proposed rule will materially undercut the effort to do so.”
Sanchez says the new rule's impact could be big, and is cause for concern. Based on a survey of Florida banks, he estimates that there are $60 billion to $80 billion of deposits in non-resident alien (NRA) accounts in Federal Deposit Insurance Corporation-insured banks in Florida. That puts a significant share of that sum at risk of moving to places such as the Cayman Islands.
“It impacts the whole state of Florida and Florida's economy,” says Sen. Garrett Richter, R-Naples, chairman of the Senate Banking and Insurance Committee. “Those accounts could move to offshore locations.”
There's roughly $400 billion in deposits in financial institutions in Florida, says Sanchez. The state's five-largest deposit markets hold $309 billion in deposits with just more than half, $157 billion, held in the Miami-Fort Lauderdale area, according to FDIC data. The Tampa Bay area comes in second with $55.8 billion.
The Florida Office of Financial Regulation estimates that for the state chartered banks, international banks and banking agencies it oversees, NRA deposits add up to $15 billion to $20 billion, a quarter of Sanchez's survey estimate. “Our bankers tell us that most of these are stable long term deposits that play a significant role in funding our banks,” wrote Cardwell, in his letter to the IRS asking that it withdraw the proposed rule.
The state agency oversees 171 state banks as well as international banks and bank agencies chartered or licensed in Florida. Combined, those financial institutions hold deposits of $65 billion, of which $15 billion is held by international banks and bank agencies.
Cardwell illustrates the impact on lending in his letter to the IRS. “It is generally agreed that bank deposits have a nine to 10 times multiplier effect on lending depending on Federal Reserve reserve requirements. As an example, withdrawal of $10 billion of deposits could result in reduced lending capacity of $90 billion or more.”
Currently, banks are required to report interest earned on bank accounts held by U.S. citizens to the IRS. The requirement doesn't apply to most foreigners, except Canadian citizens.
According to the U.S. Commerce Department, foreigners hold $10.6 trillion in passive investments in the U.S. economy, with nearly $3.6 trillion of that reported by U.S. banks and securities brokers.
Nonresident aliens have had good reasons to park their money in the United States. America's privacy laws provide personal security to foreigners from countries with unstable or corrupt governments. These foreigners are concerned that personal account information could get in the hands of criminals or terrorist groups. That, according to Sanchez, and also noted in a March letter to President Obama from the Florida congressional delegation, can lead to kidnappings or other actions by terrorists.
Also, deposit interest paid to nonresident aliens isn't taxed, something Congress has considered several times, but refrained from doing. That's been the law for more than 90 years. The main reason: to attract and keep capital in the U.S. economy, according to the delegation's letter to Obama signed by all 25 members.
The letter states that the regulation could harm U.S. financial markets, and cites a 2004 study from the Mercatus Center at George Mason University that showed that a more limited version of what's being proposed now would force an estimated $88.1 billion out of U.S. financial institutions.
The previously proposed rule in the study would have applied to 15 countries, mostly in Europe. In the end, only Canadian depositors were targeted. And Canadian citizens don't face corruption or drug cartel terrorism common in Mexico or Central and South America.
However, Jay Cochran, the study's author, says the currently proposed IRS rule would be more extensive. Cochran says he believes the rule would extend beyond the 15 European countries in the 2004 proposed rule. “That means the cost estimates in the 2004 paper are likely to be larger now,” Cochran says in a recent e-mail.
In Cochran's 2004 study, the $88.1 billion estimate represents nearly 19% of the $467 billion of deposit liabilities potentially affected by the rule as proposed at that time. But that amount is only about one-quarter of the $2.34 trillion of foreigner-owned deposits at the time, and that's grown to $3.6 trillion today. For the U.S., that means that the risk with the broader rule is potentially $684 billion, almost one-and-a-half times greater today.
For Florida, applying the 19% to the Sanchez's $60 billion to $80 billion estimate of nonresident alien deposits today results in an estimated range of $11.4 billion to $15.2 billion of deposits at risk of fleeing Florida.
Though more current data would need to be considered as part of a thorough analysis, Cochran writes in an e-mail that this “ ... rough estimate is probably as good as any as a first approximation. Then there will be less quantifiable (but no less real) 'knock on' effects that include shrinking credit availability, higher interest rates at the margin, not to mention the other more obvious costs like compliance and paperwork/recordkeeping.”
Applying Cardwell's nine or 10 times multiplier suggests that the state's loss of lending capacity could range from $102.6 billion to $152 billion. However, Cochran writes that the 10 times multiplier is theoretical, and in the current lending environment there is no multiplier effect “as banks are more selective in granting credit, and borrowers are less willing to take on debt,” he writes.
Trust the IRS?
The U.S. Treasury Department, however, dismisses the congressional delegation's implication that the rule could lead to trillions of dollars of capital exiting the U.S. and hurting the economy. “We have looked very carefully at the available data and are comfortable that the proposed regulations will not result in that outcome,” responds Michael Mundaca, the treasury's assistant secretary for tax policy, in a March 31 letter to U.S. Rep. Mario Diaz-Balart, R-Miami.
Diaz-Balart is a central figure in the policy debate. His district covers west Miami-Dade. He says he doesn't understand why the IRS needs to collect interest earnings data when there's no plan to tax it.
Mundaca argues that deposits held by foreigners with U.S. financial institutions only add up to approximately $458 billion. But because that figure includes deposits held by foreign corporations, partnerships, trusts and other entities, he claims, the “ ... deposits held by nonresident aliens are substantially less than $458 billion.”
He doesn't note how much less, however, and there's no study besides Cochran's assessing all the potential impacts of the rule. The IRS claims that an assessment is not required because in its judgment the economic effects don't exceed $100 million.
In his letter, Mundaca claims that account information would only be exchanged with countries that the U.S. has existing income tax treaties with or tax information exchange agreements. So far, that's 83 countries, including Venezuela, Mexico and Nicaragua, but the rule also opens it up to eventually include more.
Central to Mundaca's defense of the proposed rule, he writes: “ ... even when a country requests information pursuant to such an agreement, the IRS will not exchange information with that country unless it is satisfied that the country meets strict standards of confidentiality regarding the use of information ....”
In essence, as long as the IRS is satisfied, nonresident alien depositors have nothing to worry about if they're not tax evaders. “I am just shocked that the Obama administration officials would be that naÃ¯ve,” responds Sanchez. He counters that with the corruption in some of these countries that doesn't give depositors the absolute assurance they need. Their lives may be put in the hands of an IRS bureaucrat who only sees words about confidentiality on paper.
“They've never done a study about what privacy rights are protected and enforced in these countries,” says Sanchez. “It's above naivete.”