Offshore financial centres might encourage bad behaviour, such as tax evasion and
money laundering. But according to new research by Professor Andrew Rose and Dr
Mark Spiegel, published in the October 2007 issue of the Economic Journal, their net
impact on neighbouring economies is positive.
By providing competition for domestic banks, offshore banks also (inadvertently) lower
the costs for anyone using the domestic financial system. For example, simply by being
close to Andorra and Monaco, France has a more competitive banking system, which
provides more credit at lower interest rate spreads. Such indirect competitive benefits of
offshore financial centres more than offset their costs.
Offshore financial centres – such as the Cayman Islands or Panama – are jurisdictions
that oversee a disproportionate level of financial activity by non-residents. Financial
activity in them is usually dominated by the provision of intermediation services for
larger neighbouring countries.
In this study, the authors ask two distinct questions about the causes and
consequences of offshore financial centres:
• First, why do some countries become offshore financial centres?
• Second, what are the consequences of offshore financial centres for their
neighbours?
Offshore financial centres are often accused of facilitating tax evasion, money
laundering and any number of nefarious activities. Prominent offshore centres have
reputations for facilitating all manner of these unsavoury practices, though ample
opportunities for such activities may also exist for local banks with branches in
Gibraltar, Guernsey, Jersey and the Isle of Man.
All told, there are 40 offshore financial centres spread around the world, mostly in
Europe and the Caribbean (see the list below). There is widespread suspicion that most
of them reduce the costs of illicit activity in their neighbours, leading many to
characterise offshore financial centres as parasites. This study suggests that they are
more accurately viewed as symbionts than parasites.
What makes a country likely to become an offshore financial centre?
The authors approach this question using a number of different data sets.
Unsurprisingly, countries that are tax havens and money launderers host more assets
and are more likely to be offshore financial centres. These results are intuitive; one
attraction of moving assets offshore is the ability to pursue activities that are prohibited
in source countries.
Do offshore financial centres make bad neighbours?
One might expect proximity to an offshore financial centre to be bad for the
neighbourhood, since they may encourage tax evasion and other illegal activities. But
the presence of nearby offshore financial centres also has the beneficial effect of
increasing the competitiveness of a source country’s banking sector. The trade-off
between the positive and negative externalities of offshore financial centres lies at the
heart of this research.
To analyse this trade-off, the authors develop a theoretical model where offshore
financial centres have the benign effect of encouraging competition in the domestic
banking sector. They then take the predictions of the model to the data, and examine
the impact of offshore financial centres’ proximity on banking sector competitiveness
and financial depth.
The prediction that offshore financial centres have a pro-competitive impact on their
neighbours is robustly confirmed. Simply by being close to Andorra and Monaco,
France has a more competitive banking system, which provides more credit at lower
interest rate spreads.
To summarise, Rose and Spiegel find that countries identified as tax havens and
money launderers are likely to be offshore financial centres, encouraging tax evasion
and nefarious activity in neighbouring countries.
Nevertheless, offshore financial centres still provide substantial offsetting benefits in the
form of competitive stimulus for their neighbours’ financial sectors. This benign impact
on local banking conditions tends to mitigate the adverse effects of offshore financial
centres on tax evasion and illegal activity.
ENDS
Notes for editors: ‘Offshore Financial Centres: Parasites or Symbionts?’ by Andrew K
Rose and Mark M Spiegel is published in the October 2007 issue of the Economic
Journal.
Andrew Rose is Professor of Economic Analysis and Policy at the Haas School of
Business, University of California, Berkeley. Mark Spiegel is a Vice President in the
Economic Research Department of the Federal Reserve Bank of San Francisco.
For further information: contact Andrew Rose on +1-510-642-6609 (email:
arose@haas.berkeley.edu; website: http://faculty.haas.berkeley.edu/arose); or Romesh
Vaitilingam on 07768-661095 (email: romesh@compuserve.com).
Offshore financial centres
Caribbean
Aruba Bahamas Barbados Belize
Bermuda British Virgin
Islands
Cayman Islands Costa Rica
Dominica Netherland
Antilles
St. Kitts & Nevis Turks and Caicos
Islands
Europe
Andorra Cyprus Gibraltar Guernsey
Isle of Man Jersey Liechtenstein Malta
Monaco
East Asia
Hong Kong Macau Malaysia Marshall Islands
Philippines Singapore Thailand
Middle East
Bahrain Israel Kuwait Lebanon
Oman United Arab
Emirates
Other
Liberia Mauritius Morocco Panama
Russia Uruguay