Doing Business : Tiny Island Angling for Offshore Banking : Malaysia’s remote Labuan has no natural resources and little industry. But it has lots of ambition.

First, a short geography quiz: You may have heard of Grand Cayman, Malta and even Guernsey. But can you find Nauru, Vanuatu and Labuan? And what do they all have in common?

Yes, they are all fairly remote islands. But all six also are up-and-coming IOFCs, an acronym in the banking industry for international offshore financial centers. They may epitomize the term backwater, but they are attracting billions of dollars in investments and deposits.

The granddaddy of offshore banking was, of course, Switzerland, which provided overseas depositors with the first guarantees of secrecy and low taxes on their wealth. But Switzerland is highly regulated and more and more open about its banks, so depositors with money to park “offshore” have increasingly looked elsewhere.

Labuan is the latest island to join the rush for offshore banks and companies. A flyspeck on most world maps, Labuan lies just off the northern coast of the island of Borneo, about 80 miles southwest of the city of Kota Kinabalu.

The Malaysian government decided in 1989 to turn Labuan into an offshore financial center, enacting bank secrecy laws, making the island a duty-free port and imposing a corporate tax of just 3%, up to a maximum of $7,800, compared with the 40% corporate tax rate in the rest of Malaysia.

According to Ramli Othman, an official with the Malaysian Industrial Development Board, the government chose the island because it has no natural resources and little industry to provide jobs for its 50,000 inhabitants.

Malaysia wrested control of the island from the state of Sabah in 1984, and it is now ruled as a federal territory--a little bit like the District of Columbia--directly from Kuala Lumpur, the Malaysian capital. So the government of Prime Minister Mahathir Mohammed had a strong political reason for wanting to pump development dollars into the island.

Another, more cynical view of the government’s motives, which is expressed by critics on Labuan, is that senior government officials bought up land on the island at bargain prices and now stand to make large profits. In a recent court case, for example, it was revealed that a former chief minister of Sabah, Harris Mohammed Salleh, claimed to be the owner of the island’s only golf course.

A more unlikely spot for a financial center would be hard to imagine. The 35-square-mile island is a 20-minute propeller plane flight from Kota Kinabalu, which is itself not exactly world renowned.

The island had a fleeting fame in the closing days of World War II as the site of a sharp battle between Japanese and Australian forces. The airport exists thanks to the Japanese occupation army, and there are large war memorials to Japanese and Australian soldiers on opposite sides of the island.

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Before offshore banking came along, the island’s main sources of income derived from its geography: as a port to ships serving the offshore oil industry in the waters off Borneo and as a somewhat tawdry rest-and-recreation spot for expatriates resident in Brunei, which is Islamic and allows no alcohol. The main town of Labuan has a large number of crowded discotheques.

The government reckons that its location may help Labuan catch on among foreign banks because it is just two hours behind the time in Tokyo and in the same time zone as Hong Kong and Singapore. The hope is that customers will prefer to deposit their cash in a bank in the same time zone as these major financial centers rather than in one halfway around the world.

“The location of Labuan is ideal, in the heart of the Asia-Pacific region,” said Mainor Awang, general manager of the Labuan Development Authority. After three years as an active offshore financial center, Labuan has attracted 16 banks, he said, and about 250 companies have registered here.

The government hopes those numbers will swell following the completion of a huge financial park costing $148 million. The center will feature five 18-story buildings, two of them apartments and the remainder offices and shops.

In addition, two five-star hotels are under construction nearby, and a $50-million marina project is on the drawing boards.

The Malaysian government is trying to be selective about which banks are given licenses to operate in Labuan because choosing which customers can use the island’s facilities will be solely up to the banks. The belief is that prominent banks will weed out suspicious characters so that Labuan will not get the reputation as a repository for drug money that has afflicted some other offshore centers.

“If we confine ourselves to big banks that will not do something which will smear their name, that in itself is a protective measure,” said Mohammed Ibrahim, the representative of Bank Negara, Malaysia’s central bank. According to Malaysian press reports, deposits in Labuan banks are now estimated at about $1.8 billion and they have loaned $4.5 billion.

Paradoxically, most of Labuan’s business has been in Malaysia rather than overseas. By offering lower tax rates, the government made it cheaper for foreign banks to loan money to domestic Malaysian companies, so foreign banks were given an incentive to set up offices in Labuan. Most of the offices are small, and management remains behind in Kuala Lumpur.

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Anthony Ginsberg--a Los Angeles accountant who publishes a newsletter called Offshore Outlook, which specializes in covering the world’s 40 or so offshore banking centers--said he believes Labuan has great potential because of its location but that it is still not competitive with some other centers. For example, Ginsberg said, 15,000 companies a year have been registering in the British Virgin Islands and Grand Cayman. The majority of these are based in Hong Kong but incorporate overseas to protect their offshore income from Hong Kong taxes.

Ginsberg said that while Labuan charges a maximum $7,800 corporate tax a year, it is at a disadvantage compared with the British Virgin Islands and Grand Cayman, which have no taxes at all.

Ginsberg suggested that Labuan should rewrite its tax laws to compete with Grand Cayman and urged Malaysia to permit trading of actual goods in Labuan, which would allow companies to take advantage of the location as a warehousing center for cargo moving around the Pacific.

Western Samoa, another Pacific island that has gone into offshore business, lets companies register for several years at one time and allows them to use Chinese characters--a clear appeal to Hong Kong firms, Ginsberg noted.

Another paradox is that while Labuan was designated an offshore center in a bid to provide jobs for people on the island, nearly all of the people involved in the banking industry have been imported from faraway Kuala Lumpur.

“There is not very much benefit to the local people,” said Zaini Mohammed Isa, an opposition politician. “Before, all the heads of government departments in Labuan were from Labuan or at least Sabah. Now they are all from West Malaysia.”

While acknowledging the problem, government officials such as Awang of the Labuan Development Authority maintain that the local people “don’t have the expertise” and that skilled workers are needed from the start. “We have to learn from somebody,” Awang said, noting that he too is from Kuala Lumpur.

Other Centers

There are about 40 offshore banking centers in the world. Some major ones: *

EUROPE

Andorra

Channel Islands

Cyprus

Guernsey

Isle of Man

Jersey

Liechtenstein

Luxembourg

Malta

Monaco

Switzerland

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MIDEAST

Bahrain

Oman

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CARIBBEAN

Anguilla

Bermuda

Bahamas

British Virgin Islands

Cayman Islands

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PACIFIC

Marshall Islands

Nauru

Vanuatu