LABUAN, a group of tiny islands that lies off the northwest coast of Borneo in the South China Sea, may look to some like a sleepy backwater. But Malaysian Prime Minister Dr Mahathir Mohamad and his government believe Labuan's location, the region's strong growth and the uncertainty over Hongkong's future after 1997 will turn this sleepy hollow into a major tax haven for investors in the Asia/Pacific region. When Dr Mahathir announced that Labuan would be turned into an International Offshore Financial Centre (IOFC) in 1989, his critics were quick to point out the lack of communications, transport and infrastructure to support such an ambitious project. Dr Mahathir was determined to see Malaysia enter the 21st century a strong industrial nation backed by a financial services sector second-to-none in East Asia. Within a few short years, Dr Mahathir's vision has become a reality and Labuan has started to establish itself as an IOFC. Labuan has attracted a number of domestic banks and, last year, saw the Standard Chartered and Hongkong and Shanghai banks open offices. The banks are reluctant to discuss their operations on Labuan, only saying ''we are very comfortable doing business here''. To enable Labuan to compete as an IOFC, the Malaysian Government has been quick to make the conditions attractive to investors. New laws have been drafted to make it easier for financial services to relocate to Labuan to take advantage of the facilities on offer. One of the keys to Labuan's growing success is the law covering secrecy and confidentiality. The government is quick to point out that Malaysia is ''not one of those countries'' which has enacted legislation guaranteeing total banking secrecy. ''Nevertheless, Malaysia offers confidentiality to those legitimate customers who wish to keep their business and financial matters private in Labuan.'' The Offshore Banking Act (1990) also protects the identities, accounts and affairs of customers of the offshore bank, and prohibits the disclosure of any information and documents by the director or officer of the bank relating to the affairs or accountsof customers. To establish an offshore bank on Labuan, the government requires that the bank be incorporated or registered as an offshore or foreign offshore company under the Offshore Companies Act (1990). The bank must also hold a valid licence issued by the Central Bank of Malaysia or Bank Negara Malaysia under the Offshore Banking Act 1990. Once the application is approved, the annual licence fee is M$60,000 (about HK$178,000) and has to be paid no later than January 15. As an incentive for early entry, the annual licence fee payable by an applicant between 1991 and 1993 has been fixed on a pro-rata basis: that is, at M$5,000 per month. From 1994 onwards, the full annual licence fee of M$60,000 will have to be paid when the licence is granted by the government. For the banks currently operating in Labuan, business has been slow but is picking up. Deposits coming from investors in the ASEAN region, the bankers say, exceed US$700 million, while loans are in excess US$1 billion. One government official was quoted recently as saying: ''This region is growing faster than any other area in the world and we only have Hongkong and Singapore as offshore centres . . . and Labuan is right in the middle of this boom region.'' Another official in Labuan said: ''Labuan has only been an official IOFC for less than three years, so we don't expect to see the place become another Singapore overnight. ''Singapore started with deposits of US$1 billion 18 years ago and now look at Singapore. ''Today, Singapore has well over US$300 billion in deposits. With the region growing as it is, I expect Labuan will establish itself as an offshore banking centre much quicker than Singapore.'' One banker on Labuan said: ''More and more banks are looking at setting up business here and the government has gone out of its way to improve the infrastructure to make it more attractive for people with families. It could become the Bermuda of East Asia . . . only time will tell.''