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I was in Ukraine and ran into a few banks that offer anywhere from 5% to 10% interest rate on investment per annum. For example, Erste Bank is willing to pay 5,75% on 12 months deposit. I have few accounts with Chase, and those guys are offering 0.25% APY for 12 months. This made me thinking because the difference is huge.

I have looked at this question and answers there highlight the risk of investment associated with exchange rates and non-FDIC insured banks. On top of it, I still have few questions.

  • If I make an investment in USD, in foreign bank, does that imply currency conversion or no? I have heard that all financial operations must be performed in national currency. Does it mean that to deposit or withdraw money to/from bank account in foreign country, even though in US dollars, money must be converted to and from national currency?
  • Is FDIC insurance really that expensive to drop the interest from, say, 5% to 1.25%? Or otherwise why foreign banks offer that much higher rate of return?
  • I am thinking about splitting some money across many foreign banks. Is there anything else I should take into account?
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A closely related question: money.stackexchange.com/q/15246/1091 –  sharptooth Jul 11 '12 at 10:43
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2 Answers

up vote 5 down vote accepted

Part 1
Quite a few [or rather most] countries allow USD account.
So there is no conversion.

Just to illustrare;
In India its allowed to have a USD account. The funds can be transfered as USD and withdrawn as USD, the interest is in USD. There no conversion at any point in time. Typically the rates for CD on USD account was Central Bank regulated rate of 5%, recently this was deregulated, and some banks offer around 7% interest.

Why is the rate high on USD in India?
- There is a trade deficit which means India gets less USD and has to pay More USD to buy stuff [Oil and other essential items].
- The balance is typically borrowed say from IMF or other countries etc.
- Allowing Banks to offer high interest rate is one way to attract more USD into the country in short term. [because somepoint in time they may take back the USD out of India]

So why isn't everyone jumping and making USD investiments in India?
- The Non-Residents who eventually plan to come back have invested in USD in India.
- There is a risk of regulation changes, ie if the Central Bank / Country comes up pressure for Forex Reserves, they may make it difficut to take back the USD. IE they may impose charges / taxes or force conversion on such accounts.
- The KYC norms make it difficult for Indian Bank to attract US citizens [except Non Resident Indians]
- Certain countries would have explicit regulations to prevent Other Nationals from investing in such products as they may lead to volatility [ie all of them suddenly pull out the funds]
- There would be no insurance to foreign nationals.


Part 2
The FDIC insurance is not the reason for lower rates. Most countires have similar insurance for Bank deposits for account holdes.

The reason for lower interst rate is all the Goverments [China etc] park the excess funds in US Treasuries because;
1. It is safe
2. It is required for any international purchase
3. It is very liquid.

Now if the US Fed started giving higher interest rates to tresaury bonds say 5%, it essentially paying more to other countries ... so its keeping the interest rates low even at 1% there are enough people [institutions / governemnts] who would keep the money with US Treasury.

So the US Treasury has to make some revenue from the funds kept at it ... it lends at lower interest rates to Bank ... who in turn lend it to borrowers [both corporate and retail].

Now if they can borrow cheaply from Fed, why would they pay more to Individual Retail on CD?, they will pay less; because the lending rates are low as well.


Part 3
Check out the regulations

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Not all countries have bank deposit insurances, in fact I lived in one that doesn't and when a bank failed it caused a lot of problems. –  littleadv Jul 11 '12 at 17:38
    
Thanks for pointing out. Changed it to Most –  Dheer Jul 12 '12 at 4:23
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If you invest in a foreign bank you are subject to their financial rules and regulations. If you put your money with their CD it will be converted to UAH (grivna) and you will be paid back in UAH, which introduces the exchange rate risk.

FDIC is not the only reason why a CD in a US bank pays a lower interest, but it could be seen as a contributing factor.

It all comes down to risk and what the bank is willing to pay for your money, when a bank issues a CD they are entering the debt market and competing against other banks, governments, or anyone looking for money. If the yield from lending to one bank is the same as the yield of another, the logical choice would be whichever loan is less risky. So in order for the riskier bank to receive loans they must entice investors by offering a greater rate of return. In addition, if a bank isn't looking for loans they might be less inclined to pay for them. - See "What is the “Bernanke Twist” and “Operation Twist”? What exactly does it do?"

If your looking to invest in the CD's of foreign banks I would suggest doing research on their regulations. Especially if and how your money is protected in the event the bank goes bust.

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