“Pro Mundi Beneficio:” Panama’s obscure banking system explained

Since 1919, Panama’s economy has thrived on shipping and banking laws that shielded those who wanted shelter. With the revelations of the Panama Papers, can a reform-minded president deliver transparency without undermining the country’s economy?

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“At the Service of the World:” Panama’s motto reflects the key element defining the nation’s identity, history, culture, politics, and society. The recent revelations in the Panama Papers have focused world attention on this small Central American nation of less than 4 million people and the seamy underside of Panama’s history and culture as a financial and commercial hub at the service of the world economy.

Panama is a transactional society. The country has been characterized as the nation of the “deal,” where everything is for sale. A colloquial expression, juega vivo, captures the essence of a culture in which exploiting every angle and gaining advantage is seen as normal. In fact, not seeking to gain advantage when the opportunity arises is viewed as “un-Panamanian.” While this behavior is a natural outgrowth of a society in which overcoming scarcity often demands pursuing opportunities for advantage, in the context of a modern economy it can degenerate into corrupt practices. Viewed from this perspective, the Panama Papers and the activities they represent are just a manifestation of juega vivo, but on a grand scale.

How did Panama get to this point?

From the beginning of the colonial period the isthmus was a zone of transit. Panama became the center of a mercantile system based on galleons and trade with a local productive sector that, while not dedicated exclusively to supporting this system, depended on it. As a result, merchants came to dominate the economy and upper classes.

Panamanian elites developed an economic system based on monopolistic control of the transportation of goods from one ocean to the other, the renting of property and the representation of foreign interests. The pattern was reinforced in the nineteenth century by the building of the trans-isthmian railroad and the attempt by the French to build an interoceanic canal. The failure of the French canal opened the door for the United States to become the major foreign player on the isthmus.

The common understanding is that Panama’s independence from Colombia in 1903 was the product of U.S. geopolitical machinations. Certainly, the U.S. played a significant role, but by the beginning of the twentieth century Panamanian elites were convinced that only independence could further their commercial interests. But U.S. support for their independence came at a price: the United States was granted the rights to build and control the interoceanic canal. The emergence of the United States as the dominant power on the isthmus led to the development of an economy that was at the service of U.S. financial interests.

The first step was the adoption of the U.S. dollar as the legal currency. The dollar was chosen to comply with the wishes of William Howard Taft, then U.S. Secretary of War and acting director of the Isthmian Canal Commission. Taft wanted currency compatibility between Panama and the Canal Zone.

Panama’s status as a tax haven began in 1919 with the registry of foreign ships to help Standard Oil escape U.S. taxes and regulations. The shipping registry was designed to minimize taxes, regulations and disclosure requirements in order to attract foreign owners wanting to escape their home jurisdictions. U.S. ship owners wishing to sell alcohol to passengers used Panama’s registry to avoid prohibition. The registry grew after World War II as ship companies sought to avoid higher wages and improved working conditions mandated by U.S. law. Before that, JP Morgan had helped Panama introduce incorporation laws in 1927 that permitted anyone to start tax-free, anonymous corporations, thus paving the way for the country’s role in offshore finance.

The registry of ships was the primary activity of Panama’s financial service economy until the 1970s. The military government that came to power in a coup in 1968 sought to build multi-class support by promoting labor rights, seeking Panama’s control of the interoceanic waterway and broadening the commercial economy. The latter was done by developing the banking center and the Free Trade Zone in the city of Colón.

In 1970, Cabinet Decree 238 established the National Banking Commission and laid the foundation for the country’s banking and financial center. To attract offshore investments the decree forbade the investigation of the private affairs of any bank client, except under a court order. In 1970 there were 21 banks with assets of $898 million; by 1982 Panama had 125 banks with assets of $49 billion.

Another benefit of Panama’s system was the popularity of “bearer shares”—stock certificates without a designated owner. The provision effectively allowed for anonymous ownership of a corporation. By the 1980s Panama’s dollarized economy, secrecy laws, low tax environment, and substantial commercial links to the United States had become a magnet for those who sought to launder illicit capital and traffic drugs around the world.

During the 1980s, General Manuel A. Noriega used Panama’s government and banking system as a criminal enterprise at the service of Colombian drug cartels. The criminal activity and the economic sanctions aimed at removing General Noriega from power scared foreign investors, and deposits declined significantly.

After the U.S. invasion of 1989, confidence in Panama’s financial services industry returned and by 2015 the system reported $118 billion in assets, close to $10 billion more than in 2014. Today, financial services make up about eight percent of Panama’s GDP.

In the past five years, under pressure from the United States and other international organizations, Panama has signed a number of tax and information exchange treaties that have increased transparency to the system. But foreign governments and international law enforcement agencies still have to obtain a court order before banking data can be disclosed. In 2015, the country moved to regulate bearer shares to minimize anonymity and increase transparency. The new regulations were a result of international demands that Panama comply with the standards set by the OECD Global Forum on Transparency and the recommendations of the Financial Action Task Force (FATF).

Despite these positive steps, many Panamanians are wary of the impact that additional compliance will have on the lucrative financial services industry. Some see the latest revelations in the Panama Papers as an attempt to smear the “good” name of the country and undermine its growing economy. The reality is that the financial services sector employs thousands of Panamanians and is a vital part of the country’s economy. President Juan Carlos Varela is walking a fine line between meeting the demands of the international community, improving the image of Panama and preserving one of the pillars of the economy. He recently announced the establishment of a high-level commission to investigate the allegations in the Panama Papers and provide recommendations on how to improve the system. Given Panama’s history and culture one hopes the commission is not a way of kicking the problem into the long grass and avoiding the tough decisions needed to reform the system.

 

Orlando J. Pérez is the Associate Dean of the College of Arts, Humanities and Social Sciences at Millersville University and the author of Political Culture in Panama: Democracy after Invasion (Palgrave Macmillan, 2011).

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