While offshore banks provide access to many investments you simply can't buy in the United States, or only buy with great difficulty, you'll pay for the privilege. And nowhere is that truer than when you purchase securities denominated in foreign currencies. But you'll never know it unless you do some digging and then negotiate with your offshore bank to reduce those charges.
For instance, last spring a Turkish lira-denominated bond that I hold through my Austrian bank account matured. The bank credited my account for the interest. Since my base account is denominated in euros, the bank converted the liras to euros. It charged me a commission (outlined on a statement) of the lira equivalent of EUR 9 to convert the equivalent of a little under EUR 1,000 from Turkish lira to euros.
That's perfectly fair. But what the bank didn't disclose was that the foreign exchange rate they used for the currency conversion was about 1.5% above the prevailing inter-bank rate. That resulted in an undisclosed debit of around EUR 90–ten times higher than the disclosed fee.
I'm not complaining that I didn't get the inter-bank rate. As a retail customer, I understand that I won't have access to inter-bank rates for small forex transactions. It's also possible that the inter-bank rate fluctuated substantially on the day that the bank made the conversion. However, I think that they bank should have disclosed this to me, and they didn't.
A few months later, I purchased a EUR 10,000 bond denominated in New Zealand dollars. This time, the bank charged me about EUR 61 in commissions and fees. Again, I don't see this as being out of line, as it amounted to less than 1% of the purchase price of the bond. But once again, the bank didn't disclose that the foreign exchange rate they used for the currency conversion was well above the prevailing inter-bank rate—around 2.7% above it. That resulted in an undisclosed debit of around EUR 275.
The same caveats I mentioned above apply here, of course. And there are a few lessons here as well:
- If you're purchasing securities from your foreign account, try to stick to securities denominated in your base currency unless you have a compelling reason to purchase securities in another currency. (In my case, the opportunity to buy AAA-rated Turkish bonds with an 18% annual interest rate was such a reason.)
- If you do currencies, ask your account representative how far above the inter-bank rate you can expect to pay for the conversion. You're likely to pay a higher premium for relatively "exotic" currencies like the NZD than for more mainstream currencies like the euro or Swiss franc.
- If you're conducting a large transaction—above $100,000—it's fair to ask the bank to conduct it at or at least very close to the inter-bank rate. The worst they can say is "no." If they do say no, ask them to at least document on your statement how far above the inter-bank rate the forex exchange was conducted.
Incidentally, if you're a U.S. taxpayer, you can't deduct these hidden debits on your tax return. You have to add them to your basis in that security, and then use that higher basis to reduce whatever capital gain—or increase whatever capital loss—you have upon sale or redemption.
Copyright © 2009 by Mark Nestmann
(An earlier version of this post was published by The Sovereign Society)