Wednesday, May 11, 2011

New French report on financial instability uses TJN data

This is adapted from the Treasure Islands blog:

The French newspaper L'Expansion is carrying an article in French, with a rough web translation here. It is commenting on a report from the French government's Centre d'analyse stratégique (Centre for Strategic Analysis.)

The report identifies 50"Offshore Financial Centres (OFCs)" or "prudential havens" as it calls some of them, and the newspaper summarises the report by saying

"These OFCs have played a major role in the production of financial engineering for the rest of the world. Their degree of financial integration with traditional financial centres makes them decisive actors in propagating systemic risk during the crisis."

This much is incontrovertible - perhaps they've been reading Treasure Islands, or looking at things like this?

The report looks at characteristics of these places: low or zero tax, secrecy, and political stability. Look at the Treasure Islands definition of a tax haven, or secrecy jurisdiction:

"A place that seeks to attract business by offering politically stable facilities to help people or entities get around the rules, laws and regulations of jurisdictions elsewhere."

Their definitions aren't exactly the same as the TI definition - but there's clearly a lot in common. And if you look at the last page of the original report - here - the report uses our Financial Secrecy Index in constructing its classifications.

There's more. The report classifies these places into three categories:

  • Small jurisdictions that are significant players - such as Luxembourg, Cayman, Bahamas, Jersey, Guernsey, Mauritius, and so on.
  • Small jurisdictions with relatively small offshore industries: Andorra, Aruba, Brunei, and various others.
  • And here we have a courageous classification. This one includes Belgian, Ireland, Malta, the Netherlands and . . . the City of London.

Yes! This isn't the same three-way classification made in Treasure Islands - this one looks more at the functions of the places, rather than their historical and political relationships - but we won't argue with it.

It takes guts to finger these powerful countries - so many congratulations to this effort. And, as argued in a recent blog about Ireland - it's incredibly important not to chicken out of pointing the finger at countries where this is appropriate.

The report makes four key proposals:

  1. When classifying these jurisdictions, use a range of different criteria that aren't just about tax - such as exploring prudential ratios, and the size of "shadow banking" operations.
  2. Make "onshore" banks reveal the effective location of their ultimate exposure to risks (this is potentially an interesting corollary to TJN's Country-by-country reporting project.)
  3. Install at the IMF and the Bank for International Settlements a division charged with systemic risks, financial innovation - including that created offshore.
  4. Ensure that financial institutions have enough capital in relation to their contribution to systemic risk, taking into account all their international inter-dependences.

That seems like very sensible advice. Points 3 and 4 are more standard fare and have been recommended elsewhere - but points 1 and 2 are stunningly important.

The original report on which the story is based upon is summarised here, and the report itself is here.

For a lot more detail on how and why tax havens, or secrecy jurisdictions, helped cause the global financial crisis, see here.

Update: the translated text of the abstract of the French report is as follows:

Offshore financial centres and the shadow banking system

The financial crisis has brought to light the crucial role of the shadow banking system in the propagation of systemic risk. This system refers to most of the little or unregulated financial institutions, among which some took advantage of the potential regulatory circumventions by using offshore jurisdictions. “Tax haven”, the usual French term, has become too restrictive to apply to those jurisdictions, which are not only used to evade taxes, but also as regulatory and legal havens. The offshore financial centres (OFCs) or “prudential havens” are nowadays seen as “fault lines” of the macroprudential supervision needed to ensure the stability of the entire financial system. How can we prevent these “blind spots” in financial regulation from being overlooked?

Their recurring appearance in suspicious financial strategies gives a hint of their dodgy role. However, the lack of data and operational analysis usually prevents us from going further than the usual “naming and shaming”. This report intends to better understand OFCs, a vague concept from a legal standpoint, by examining the following characteristics: low or zero tax, secrecy, and political stability. Exploring the data highlights their major role in the production of financial engineering for the rest of the world, leading us to compile a list of jurisdictions that we classify as OFCs. Finally, the report determines their degree of financial integration with traditional financial centres, which played a decisive role during the global crisis and thus leads to four key proposals.

To minimize the appeal of those “blind spots” in financial regulation, one possible solution for the regulator is to raise the costs of going offshore for the conventional banking institutions. In order to improve oversight of OFCs, the first step will be to ensure adequate surveillance regarding fiscal, legal and prudential matters occurring in those jurisdictions. To curb the transactions between regulated and unregulated institutions, offshore exposure must be fully disclosed by the conventional banking system. With that information, the authority responsable for regulation can ensure that those institutions are sufficiently capitalized in regards to risky positions.

1. Make a ranking of those jurisdictions, using a range of different criteria (tax level, prudential ratios, the size of shadow banking operations, etc.), in order to improve the transparency of their fiscal and prudential regulation.
2. Make “onshore” banks reveal the effective location of their ultimate exposure to risks, including their exposition offshore.
3. Install, at the IMF or the Bank for International Settlements, a division charged with systemic risks, financial regulation and innovation – including that created offshore.
4. Ensure that financial institutions have enough capital relative to their contribution to systemic risk, taking into account all their international interdependences.




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