Bankers on the Beach

• Author: Maria Gonzalez and Alfred Schipke
• Position: the IMF's Resident Representative to Argentina and Uruguay, and is a Division Chief in the IMF's Western Hemisphere Department.

Host countries see such activities as a source of growth and a legitimate area for economic diversification. For critics, OFCs are a stark reflection of the severe problems—including tax evasion and money laundering—triggered by the lack of transparency and regulation that comes with unfettered globalization. For this reason, several international bodies, including the Financial Stability Board (FSB), the Financial Action Task Force (FATF), and the Global Forum/Organization for Economic Cooperation and Development (OECD), have launched or reinvigorated initiatives to strengthen the tax and financial regulatory policies under which OFCs operate.

Broad reach

Many OFCs attract large foreign financial flows, and OFCs’ financial sectors often exceed the size of their respective host economies. OFCs’ financial services operate through a variety of instruments, ranging from international banking and insurance to the structured investment vehicles that were at the center of the 2008–09 global economic and financial crisis (see Box 1; Lane and Milesi-Ferretti, 2010; and Hines, 2010).

Box 1. At your service

Offshore financial centers (OFCs) offer a menu of financial services.

International banking: Individuals and corporations in politically or economically unstable countries protect their assets by placing them overseas and avoiding scrutiny.

Headquarters services: For certain types of firms, there are legal and tax advantages to incorporating in an OFC. According to the U.S. Government Accountability Office (GAO, 2008), about 732 companies trading on U.S. stock exchanges, including Coca-Cola, Oracle, and Seagate Technology, reported to the U.S. Securities and Exchange Commission that they are incorporated in the Cayman Islands. Some firms opt to locate their head office in an OFC, with onshore activities being conducted by affiliates of the offshore headquarters.

Foreign direct investment: OFCs play an important role in the internal organization of multinational firms. For instance, the financial management and treasury operations of multinationals typically include offshore affiliates that support certain transactions, such as new acquisitions or mergers, or that permit foreign direct investment to be financed with debt rather than equity.

Structured finance: Before the 2008–09 economic crisis, many banks and hedge funds used OFCs for off-balance-sheet activities such as the so-called special purpose vehicles or structured investment vehicles. These vehicles were typically funded in onshore financial markets and purchased onshore assets.

Insurance: Commercial operations may establish an insurance company in an OFC to manage risk and minimize taxes, or onshore insurance companies may establish an offshore company to reinsure certain risks and reduce the onshore company's reserve and capital requirements.

Collective investment schemes: OFCs have participated in the hedge fund industry by housing feeder funds that gather clients' contributions, which are then managed by onshore master funds. In addition, leveraged feeder funds may borrow from offshore and onshore banks.

OFCs need to compete with onshore institutions. On the one hand, to attract business, they tend to offer low- or zero-taxation schemes that appeal to firms seeking to cut...