Financial centers. Plan

Financial centers.
Plan:

1. 
   International financial centers.
   
2. 
   Financial innovation
   

In accordance with the directive in its Terms of Reference (page xiii), the Working Party has examined the effects on balance of payments accounting of both the proliferation of offshore financial centers and the spreading use of new financial instruments. However, as it would go beyond the scope of this report to present a detailed analysis of the complex nature of cross-border transactions involving such centers and instruments, this section looks primarily at the distortions which these transactions may cause in the international investment income account, with brief reference to other types of transactions. Some estimates of the extent to which transactions performed via offshore centers have contributed to the discrepancies in the global investment income account are given in earlier chapters. The net effect of the various adjustments found to be necessary for the income accounts was small in the years covered by our study, but there were sizable omissions of both debits and credits. The size of these omissions has probably grown substantially since 1983. Innovations in financial techniques have created statistical problems of increasing severity that will require some rethinking of the standard categories used in the balance of payments accounts and changes in data collection techniques.

INTERNATIONAL FINANCIAL CENTERS
a. Principal Features
Mainly for historical reasons, but also because of different characteristics, two broad categories of international financial centers (IFCs) can be distinguished: the traditional—or classical—IFCs located in Europe and the United States, which evolved during the nineteenth and early twentieth centuries, and the offshore financial centers (OFCs), which are a relatively recent, post-World War II phenomenon.
The traditional IFCs emerged in response to demands for financial services related to interregional and international trade and investment. Their growth was stimulated by access to ample sources of capital, the development of professional and technical skills, good communication facilities; and, more generally, the business and personal connections required to provide the banking, insurance, and other financial services needed by traders, shipping firms, and investors. In addition, these centers enjoyed political stability and laissez-faire policies which allowed unfettered trade and capital flows. Activity in the IFCs—which had dwindled in the years of depression in the 1930s—began to expand gradually after World War II and received a major impetus from the advent of the Eurocurrency markets in the early 1960s, which greatly enhanced their appeal as low-cost and highly efficient conduits for transactions with and among nonresidents.
The OFCs are of relatively recent origin and owe their existence to the deliberate attempts of the authorities in these centers to offer a range of advantages which were not available, or not available to the same extent, in the traditional IFCs. The various incentives provided in the OFCs attracted captive insurance companies, shipping companies, and other nonfinancial firms to set up management and holding companies in these centers and to shift a part of their operations to them. More importantly, however, favorable and flexibly administered tax laws and exchange controls, as well as the virtual freedom from banking and other regulations or restrictions on operations, induced banks to transfer business to these centers. Indeed, the very large volume of international banking business, which is completely unrelated to the size of the domestic market, is the single most prominent feature of all OFCs. The banks which engage in offshore business in these centers can be broadly divided into two groups. First, there are “letter-box” or “brass-plate” companies which act as legal and booking channels for business that is in fact conducted elsewhere—to a large extent in the traditional financial centers located in the countries of residence of the banks which control the letter-box companies. The second group of banks has genuine transactions offices—that is, they conduct banking operations consisting of deposit banking and final lending with business conducted with at least some measure of independent decision making.
While all international financial centers offer certain basic services, such as relative freedom from some taxes and regulations, anonymity, and efficiency in effecting transactions, there is also a considerable amount of specialization in the attractions offered to customers. The older centers provide a wide range of services though, of course, London is clearly the dominant center in the Eurobond market, while Swiss banks are preeminent in offering custodial and other services to their depositors.
Among the OFCs, there is a general tendency to impose no income taxes on financial intermediaries or their customers or to have only nominal income tax rates. Few have any capital gains taxes; commonly there is no taxation of foreign-source income; and individuals taking up residence may be free of estate taxes. In addition to the use of widespread and sometimes specially designed tax incentives, some OFCs have established favorable regimes for particular industries. Thus, for example, insurance operations are centered in Bermuda and, to a lesser extent, in The Bahamas, the Channel Islands, and the Isle of Man, while Liberia and Panama have been established for many years as advantageous countries in which to register ships. In recent years many companies, especially U.S. companies, found that because of the tax situation, it was advantageous to conduct their international borrowing operations via a specialized subsidiary in the Netherlands Antilles or subsidiaries in some other offshore centers. Changes in the tax situation have now greatly reduced that advantage. In general, however, it seems fair to say that any interference with market efficiency that results from attempts to tax or regulate will quickly result in the creation of some special provision in some OFC which will attempt to neutralize the effect of such actions. As these new channels for flows are opened, usually without any attempt at balance of payments accounting, the task of the balance of payments compiler is made harder.
Some statistics can be cited that will illustrate the size and growth rates of the international business of the main financial centers. In Table 60 the growth of the foreign assets of banks located in both old and new financial centers can be seen, as they doubled from $1,000 billion in 1979 to $2,100 billion at the end of 1985. The increase in the share of MOB centers can also be seen, and it would have been even greater (and the share of the United States substantially less) except for the switch of funds to head offices located in the United States that occurred when international banking facilities were initially allowed in the United States at the end of 1981.
Table 60