Deposit Protection in Puerto Rico

Bank Account Holders in Puerto Rico: Protect Your Account Balance
When Banks With or Without Deposit Insurance Fail or Stop

Puerto Rico is an island in the Caribbean. The official languages spoken by the 3.2 million residents are Spanish and English.  Prior to the United States declaring Puerto Rico an unincorporated organized territory, it was colonized by Spain. Spain originally implemented a legal system based on civil law, which was later influenced by US common law. Governmental powers are delegated by the US Congress. Despite being governed by US federal law, Puerto Rico is allowed to exercise its own self-governance similar to the US states. Due to its status as an unincorporated territory, the US constitution exclusively applies to fundamental rights. As well as being United States citizens, people born in Puerto Rico are also citizens of the Commonwealth of Puerto Rico. This peculiar situation also has an effect on taxation. Puerto Ricans pay different federal taxes, make Social Security contributions in the USA and may be – under specific circumstances – exempt them from other taxation.

By Latin American standards, Puerto Rico has a high income economy, but in American terms it is underdeveloped. In the absence of natural resources, the territory is vulnerable to international instability, US foreign policy, and trade restrictions. The oversized public sector has a severe impact on government finance and created a structural deficit over time. Accumulation of public debt for more than two decades became unmanageable in 2017. The government defaulted on its USD 72 Billion debt obligation. As a result, credit rating agencies downgraded Puerto Rico government bonds to speculative non-investment grade junk status. Congressional intervention was necessary. It enacted PROMESA, which established an oversight board. Despite these efforts, fiscal challenges on the islands remain.

The Economy and Financial Sector in Puerto Rico

Agriculture has traditionally been the main economic driver. The information age contributed to a transition to an industrial economy. Macro-economic challenges and the slow decline of public debt still places a burden on society. Basic services and infrastructure have been chronically neglected and are gradually being upgraded. The Puerto Rican open economy is dependent on external trade. As a result, the territory is vulnerable to global recessions in which trade declines and pricing levels are under pressure. The public sector remains an important employer for local workers. Manufacturing is the primary driver of the Puerto Rican economy whilst privately owned enterprises in the services sector are on the rise. Tourism, real estate, international business and conventions, and (offshore) finance play an important role. The territory uses the US dollar as its currency. The US treasury has therefore jurisdiction over the payment system in Puerto Rico.

As many micro-jurisdictions and independent Caribbean islands, Puerto Rico provides tax advantages to foreign investors, high-net worth individuals, corporations and providers of innovative financial technology. The financial sector is of importance to the well-functioning of this ecosystem and thus rather substantial. US Federal regulations govern the sector managed by the Federal Reserve Bank of New York.

Banking in Puerto Rico

The Puerto Rican banking system comprises local banks, International Financial Entities, and branches of foreign financial institutions. The banking sector is regulated by the Laws of Puerto Rico, Title Seven on banking (hereafter referred to as the Banking Act), the International Financial Entities Act and the International Banking Center Regulatory Act. Supervision is primarily mandated to the Puerto Rican Office of the Commissioner of Financial Institutions and the framework of US Federal institutions. These include, among others the FRB, the FDIC and FinCEN. Financial institutions that operate in the territory are subject to US anti-money laundering statutes. These include the Patriot Act and the Bank Secrecy Act.

International Financial Entities, Electronic Money Institutions and challenger banks find their way to Puerto Rico for the efficient and flexible legal environment and administrative framework. Most activities with Puerto Ricans are prohibited for these foreign financial institutions and the legal entity is exempted from paying federal income tax. As a result, a shift in risk management from traditional banking risk originating from retail banking, lending and proprietary trading to international compliance and conduct risk becomes paramount. Most assets of a foreign financial institution or online bank are held outside of Puerto Rico in the correspondent banking and custodian system. Such holdings are under normal circumstances relatively safe for domestic challenges and natural disasters.

Financial institutions operating in Puerto Rico must maintain sufficient capital ratios. Capital adequacy and asset quality are important to absorb institutional financial shocks. The Basel framework is followed and implemented in local bank regulation applicable to both domestic banks and International Financial Entities. Fully paid capital stock and a reserve fund is required to start and maintain a bank. Throughout its life cycle, financial institutions should remain flexible towards its regulatory capital to balance financial safety, public confidence and economic growth. Deposit taking financial institutions in Puerto Rico shall therefore maintain a legal reserve up to 30% of their total obligations, payable on sight.

Taxation and the Common Reporting Standards

Local tax regulation often requires tax payers to share their international financial holdings with their respective tax authorities. Deliberate evasion and the laundering of illicit proceeds undermines the confidence in the global financial system. In 2014, the OECD formulated a system for the automatic exchange of information between tax authorities with data presented by supervised financial institutions. This Common Reporting Standard (CRS) is based on the Foreign Account Tax Compliance Act (FATCA) and applies to states that undersign the Convention on Mutual Administrative Assistance in Tax Matters.

Taxation in Puerto Rico is source based. This means that personal and corporate income earned within the country is taxed unless it is exempted. International business and foreign direct investment can rely on some generous fiscal advantages. Individuals pay personal taxes based on their residency status and the number of days they spend on the islands each year. As an unincorporated US territory, financial institutions that operate on the islands are subject to FATCA. Automatic exchange of (financial) information between tax authorities under CRS however does not apply.

International initiatives, such as the Financial Action Task Force (FATF) and the Joint Chiefs of Global Tax Enforcement (J5), aim to address money laundering techniques and trends and combat transnational tax crime. Puerto Rico and in particular one of its IFE’s has recently been on the radar of the J5. The investigation referred to as Operation Atlantis, revealed several critical weaknesses in the regulatory environment and triggered further scrutiny of international bank customers by the responsible authorities.

Deposit Protection in Puerto Rico

Non-domestic international financial entities and local deposit-taking credit institutions are distinguished for deposit insurance purposes. The original objective of deposit insurance is to protect and maintain confidence in the local financial system and protect the public interest. Deposit insurance is capped to levels that protect the bank deposits of most retail customers and small and medium sized enterprises. Furthermore, such protection exclusively applies to members of a deposit guarantee scheme. In Puerto Rico, only five deposit taking credit institutions currently participate in the FDIC. These institutions are Banco Popular de Puerto Rico, Banco Santander Puerto Rico, Firstbank Puerto Rico, Oriental Bank and Scotiabank de Puerto Rico. To avoid losing money if their institution closes, customers of licensed and supervised International Financial Entities should consider alternative fund recovery strategies. Find out more about the Puerto Rico Deposit Guarantee Scheme here.

Bank Resolution, Receivership and Winding Up

Financial institutions in Puerto Rico are placed into receivership because of unsound financial conditions, their unwillingness to cooperate with regulatory inspections, or violations of law or charters. Liquidation is triggered by expiration of term, loss of capital or by the vote of shareholders. A bank fails when it is unable to meet its obligations to depositors and other creditors. The competent authorities to determine whether a bank fails are the Commissioner and he FDIC. To preserve the value of the assets of the failed institution, no advance notice is given to the public when a financial institution is closed or other emergency provisions are imposed. The objective of early intervention is investigate the feasibility of reopening, reorganization or liquidation of the bank. Notable bank failures in the Puerto Rico include:

  • Westernbank Puerto Rico (30/04/2010): The chairman of a public pharmaceutical company obtained several loan agreements totalling USD 142 million from Westernbank in exchange for fabricated collateral. When the loan defaulted, losses for the bank exceeded USD 100 million. The Office of the Commissioner of Financial Institutions closed Westernbank and appointed the FDIC as the official receiver. The FDIC subsequently seized all deposits and assets. These deposit accounts were later transferred to Banco Popular de Puerto Rico and Westernbank was dissolved. The FDIC determined that insufficient assets exist in the receivership of Westernbank to make any distribution to general unsecured claims, and therefore such claims will recover nothing and have no value.

  • Doral Bank (27/02/2015): A series of events led to the closure of Doral Bank. The bank experienced eight years of consecutive losses while share value declined and an invalid tax refund was used as regulatory capital. The determination of invalidity was made by the appeals court and initiated the closure of the bank by the Office of the Commissioner of Financial Institutions. The FDIC was appointed as receiver and deposits accounts were transferred to Banco Popular de Puerto Rico. These deposit accounts were available immediately and without restriction. Creditors with claims against the failed institution were able to submit such claims in writing to the official receiver.

The case studies of Westernbank and Doral Bank indicate that assets of the bank are sold into the marketplace promptly. It also reveals that a strict order is followed when banks fail to maintain public confidence and financial stability. The license to operate is temporarily blocked or revoked, the offices are closed, a moratorium on payments is announced and an external administrator or receiver is appointed to prepare for the resolution. An acquirer for the assets and liabilities of the bank is sought and assets and liabilities are then transferred to the acquirer.

Asset Recovery for International Creditors

The  financial industry is subject to unpredictable external variables that cause risk and reward. These include but are not limited to employment, consumer confidence, and supply and demand. Bank risk management identifies risk patterns and considers volatility in asset prices and share value. Some events however cannot be avoided and regulatory intervention is justified to maintain public confidence in the financial system and protect bank deposits. Financial institutions in Puerto Rico may obtain liability insurance for its staff members to safeguard them from actions arising from their position. Bank directors can be held personally liable for a knowingly violation of the Banking Act.

There is a distinct risk profile for international creditors compared to local bank customers. They have different needs and in order to manage their financial affairs, they often use international business corporations. Several International Financial Entities incorporated in Puerto Rico tailor their services to this international clientele. They offer a variety of FX solutions, reliable international payments systems and bank cards. From the perspective of funding and matching fractional reserve lending and full reserve banking systems may be used. Both have advantages and disadvantages. Assets are then held outside the jurisdiction in system of correspondent and custodian banks.

Following paragraph 205 of the Banking Act, the Governor of Puerto Rico may instruct the Secretary of the Treasury to restrict withdrawal of deposits and impose statutory administration when excessive withdrawals or other reasons not implying insolvency occur. As a result, creditors are treated in a fair and impartial way when distribution of assets takes place. The creditor hierarchy and positions of claimants is then warranted. Creditors who are wronged by the bank or its management must submit evidence to the court showing that their position should be prioritized over other claimants.

Contact us for More Information and to Discuss Your Case…

This website is an initiative of Legal Floris LLC. We assist international creditors recover money when their bank fails or their investments disappears. Due to our vast experience in bank failures in different countries, we are able to maximize repayments and minimize risks for our clients. Contact us right now to find out how we can help you too to reclaim your account balance if your bank in Puerto Rico stops operating:

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