Article Details

Offshore Financial Centers

Nada Almutawa
27/05/2009 12:00 AM

Offshore Financial Centers
IMF Background Paper

Prepared by the Monetary and Exchange Affairs Department
June 23, 2000


  1. Introduction
  2. Offshore Finance and Offshore Financial Centers
    1. What It Is and Where It Is Done
    2. How Significant Is Offshore Finance?
    3. How Has the Business Evolved?
    4. How Is Offshore Finance Carried Out?

  3. International Policy Initiatives


  1. Examples of Uses of Offshore Financial Centers (OFCs)
  2. Minimum Standards for the Supervision of International Banking Groups and their Cross-Border Establishments

Text Tables

  1. Countries, Territories, and Jurisdictions with Offshore Financial Centers
  2. Basic Facts on OFCs Considered by the Financial Stability Forum
  3. Offshore Issues: Synopsis of International Policy Initiatives


  1. Activities in OFCs
  2. Banks` Net Cross-Border Assets


I.  Introduction

The existence of offshore financial centers (OFCs) affects the work of the Fund in several ways. First, a better understanding of the activities taking place in OFCs can contribute to strengthening financial system surveillance by improving abilities to identify and deal with surrounding risks at an early stage. Second, OFCs are generally used not only by major industrial countries, but also by emerging market economies whose financial systems are perhaps more vulnerable than others to reversals in capital flows, rapid accumulation of short-term debt, unhedged exposure to currency fluctuations, and selective capital account liberalization. Finally, the operation of OFCs has implications for the Fund`s work on the promotion of good governance because it can reduce transparency, including through the exploitation of complex ownership structures and relationships among different jurisdictions involved.

Following discussions in various international fora, including the Fund`s Interim Committee and the G-7 Ministers of Finance,1 the Financial Stability Forum (FSF) established a working group to look into the workings of OFCs and their impact on financial stability. As a result of the working group`s report, the FSF has recommended a system of assessment for a number of OFCs which may have implications for the Fund`s work on the assessment of financial stability in general, and for the joint IMF-World Bank Financial Sector Assessment Program (FSAP) in particular.

The purpose of this paper is to provide background information on the business of OFCs and on a number of initiatives taking place in various international fora concerning OFCs. A companion paper addresses the main policy issues stemming from a possible involvement of the Fund in the assessment of OFCs.

This paper is organized as follows.2 Chapter II describes what is meant by the business of offshore finance, where it takes place, and presents a number of definitions of an OFC. It describes the principal activities involved, notes the lack of data on many aspects, and discusses why OFCs are used. Most of the discussion relates to banking because that is the only sector for which statistics are available. Chapter III describes the various initiatives that are being taken in a variety of international fora affecting OFCs.

II.  Offshore Finance and Offshore Financial Centers


A.  What It Is and Where It Is Done

Offshore finance is, at its simplest, the provision of financial services by banks and other agents to non-residents. These services include the borrowing of money from non-residents and lending to non-residents. This can take the form of lending to corporates and other financial institutions, funded by liabilities to offices of the lending bank elsewhere, or to market participants. It can also take the form of the taking of deposits from individuals, and investing the proceeds in financial markets elsewhere. Some of these activities are captured in the statistics published by the Bank for International Settlements (BIS). Probably rather more significant are funds managed by financial institutions at the risk of the customer. Such off-balance sheet, or fiduciary, activity is not generally reported in available statistics. Furthermore, significant funds are believed to be held in OFCs by mutual funds and trusts, so-called International Business Companies (IBCs), or other intermediaries not associated with financial institutions.

The definition of an OFC is far less straightforward. At its broadest, an OFC can be defined as any financial center where offshore activity takes place. This definition would include all the major financial centers in the world. In such centers, there may be little distinction between on- and offshore business, that is a loan to a non-resident may be funded in the center`s own market, where the suppliers of funds can be resident or non-resident. Similarly, a fund manager may well not distinguish between funds of resident customers and those of non-residents. Such centers, e.g., London, New York, and Tokyo could more usefully be described as "International Financial Centers" (IFCs). In some cases, e.g., New York and Tokyo, some of this activity, but by no means all, is carried on in institutions which are favorably treated for tax and other purposes, e.g., the U.S. International Banking Facilities (IBFs) and the Japanese Offshore Market (JOM).

A more practical definition of an OFC is a center where the bulk of financial sector activity is offshore on both sides of the balance sheet, (that is the counterparties of the majority of financial institutions liabilities and assets are non-residents), where the transactions are initiated elsewhere, and where the majority of the institutions involved are controlled by non-residents. Thus OFCs are usually referred to as:

  • Jurisdictions that have relatively large numbers of financial institutions engaged primarily in business with non-residents;



  • Financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economies; and



  • More popularly, centers which provide some or all of the following services: low or zero taxation; moderate or light financial regulation; banking secrecy and anonymity.


However, the distinction is by no means clear cut. OFCs range from centers such as Hong Kong and Singapore, with well-developed financial markets and infrastructure, and where a considerable amount of value is added to transactions undertaken for non-residents, to centers with smaller populations, such as some of the Caribbean centers, where value added is limited to the provision of professional infrastructure. In some very small centers, where the financial institutions have little or no physical presence, the value added may be limited to the booking of the transaction. But in all centers specific transactions may be more or less of an "offshore" type. That is in all jurisdictions it is possible to find transactions where only the "booking" has taken place in the OFC, while at the same time business involving much more value added may also take place.

In addition to banking activities, other services provided by offshore centers include fund management, insurance, trust business, tax planning, and IBC activity. Statistics are sparse—but impressions are of rapid growth in many of these areas in recent years, in contrast to some decline in banking (see Section C below). Box 1 provides examples of uses of OFCs.

Box 1. Examples of Uses of Offshore Financial Centers (OFCs)

Offshore banking licenses. A multinational corporation sets up an offshore bank to handle its foreign exchange operations or to facilitate financing of an international joint venture. An onshore bank establishes a wholly owned subsidiary in an OFC to provide offshore fund administration services (e.g., fully integrated global custody, fund accounting, fund administration, and transfer agent services). The owner of a regulated onshore bank establishes a sister "parallel" bank in an OFC. The attractions of the OFC may include no capital tax, no withholding tax on dividends or interest, no tax on transfers, no corporation tax, no capital gains tax, no exchange controls, light regulation and supervision, less stringent reporting requirements, and less stringent trading restrictions.

Offshore corporations or international business corporations (IBCs). IBCs are limited liability vehicles registered in an OFC. They may be used to own and operate businesses, issue shares, bonds, or raise capital in other ways. They can be used to create complex financial structures. IBCs may be set up with one director only. In some cases, residents of the OFC host country may act as nominee directors to conceal the identity of the true company directors. In some OFCs, bearer share certificates may be used. In other OFCs, registered share certificates are used, but no public registry of shareholders is maintained. In many OFCs, the costs of setting up IBCs are minimal and they are generally exempt from all taxes. IBCs are a popular vehicle for managing investment funds.

Insurance companies. A commercial corporation establishes a captive insurance company in an OFC to manage risk and minimize taxes. An onshore insurance company establishes a subsidiary in an OFC to reinsure certain risks underwritten by the parent and reduce overall reserve and capital requirements. An onshore reinsurance company incorporates a subsidiary in an OFC to reinsure catastrophic risks. The attractions of an OFC in these circumstances include favorable income/withholding/capital tax regime and low or weakly enforced actuarial reserve requirements and capital standards.

Special purpose vehicles. One of the most rapidly growing uses of OFCs is the use of special purpose vehicles (SPV) to engage in financial activities in a more favorable tax environment. An onshore corporation establishes an IBC in an offshore center to engage in a specific activity. The issuance of asset-backed securities is the most frequently cited activity of SPVs. The onshore corporation may assign a set of assets to the offshore SPV (e.g., a portfolio of mortgages, loans credit card receivables). The SPV then offers a variety of securities to investors based on the underlying assets. The SPV, and hence the onshore parent, benefit from the favorable tax treatment in the OFC. Financial institutions also make use of SPVs to take advantage of less restrictive regulations on their activities. Banks, in particular, use them to raise Tier I capital in the lower tax environments of OFCs. SPVs are also set up by non-bank financial institutions to take advantage of more liberal netting rules than faced in home countries, reducing their capital requirements.

Tax planning. Wealthy individuals make use of favorable tax environments in, and tax treaties with, OFCs, often involving offshore companies, trusts, and foundations. There is also a range of schemes that, while legally defensible, rely on complexity and ambiguity, often involving types of trusts not available in the client`s country of residence. Multinational companies route activities through low tax OFCs to minimize their total tax bill through transfer pricing, i.e., goods may be made onshore but invoices are issues offshore by an IBC owned by the multinational, moving onshore profits to low tax regimes.

Tax evasion and money laundering. There are also individuals and enterprises who rely on banking secrecy to avoid declaring assets and income to the relevant tax authorities. Those moving money gained from illegal transaction also seek maximum secrecy from tax and criminal investigation.

Asset management and protection. Wealthy individuals and enterprises in countries with weak economies and fragile banking systems may want to keep assets overseas to protect them against the collapse of their domestic currencies and domestic banks, and outside the reach of existing or potential exchange controls. If these individuals also seek confidentiality, then an account in an OFC is often the vehicle of choice. In some cases, fear of wholesale seizures of legitimately acquired assets is also a motive for going offshore. In this case, confidentiality is very important. Also, many individuals facing unlimited liability in their home jurisdictions seek to restructure ownership of their assets through offshore trusts to protect those assets from onshore lawsuits. Some offshore jurisdictions have legislation in place that protects those who transfer property to a personal trust from forced inheritance provisions in the home countries.

Source: Financial Stability Forum`s Working Group on Offshore Financial Centers Report (April 2000).


These broad definitions, together with the fact that statistics are available for only a part of the business and only for some OFCs, have shaped the coverage of OFCs by international financial institutions and commentators, ranging from the 14 OFCs listed in the joint BIS-IMF-OECD-World Bank statistics on external debt to the 69 OFCs listed in Errico and Musalem (1999).3 Table 1 provides a list of countries, territories, and jurisdictions with OFCs according to coverage.

Table 1. Countries, Territories, and Jurisdictions with
Offshore Financial Centers

Africa Asia and Pacific Europe Middle East Western Hemisphere

Djibouti Cook Islands (FSF) Andorra (FSF) Bahrain (J) (OG) (FSF) Anguilla (FSF)
Liberia (J) Guam Campione Israel Antigua (FSF)
Mauritius (OG) (FSF) Hong Kong, SAR (J) (OG) (FSF) Cyprus (OG) (FSF) Lebanon (J) (OG) (FSF) Aruba (J) (OG) (FSF)
Seychelles (FSF) Japan1 Dublin, Ireland (FSF)   Bahamas (J) (OG) (FSF)
Tangier Labuan, Malaysia (FSF) Gibraltar (OG) (FSF)   Barbados (J) (OG) (FSF)
  Macao, SAR (FSF) Guernsey (OG) (FSF)   Belize (FSF)
  Marianas Isle of Man (OG) (FSF)   Bermuda (J) (OG) (FSF)
  Marshall Islands (FSF) Jersey (OG) (FSF)   British Virgin Islands (FSF)
  Micronesia Liechtenstein (FSF)   Cayman Islands (J) (OG) (FSF)
  Nauru (FSF) London, U.K.   Costa Rica (FSF)
  Niue (FSF) Luxembourg (FSF)   Dominica
  Philippines Madeira   Grenada
  Singapore2(J) (OG) (FSF) Malta (OG) (FSF)   Montserrat
  Tahiti Monaco (FSF)   Netherlands Antilles (J) (OG) (FSF)
  Thailand3 Netherlands   Panama (J) (OG) (FSF)
  Vanuatu (J) (OG) (FSF) Switzerland (FSF)   Puerto Rico
  Western Samoa (FSF)     St. Kitts and Nevis (FSF)
        St. Lucia (FSF)
        St. Vincent and Grenadines (FSF)
        Turks and Caicos Islands (FSF)
        United States4
        West Indies (UK) (J)5