Offshore Financial Centers
IMF Background Paper

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.

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.

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.