Offshore financial centers (OFCs), with their array of tax and regulatory incentives for nonresident investors and the complete flexibility granted to the management of foreign assets, have challenged the supremacy of the large industrial countries’ financial centers. The emergence and growth of OFCs during the last three decades can be attributed primarily to regulations and taxes imposed in the industrial countries during the 1960s and 1970s, which provided incentives for firms to relocate some of their financial activities to offshore or Eurocurrency markets. By some estimates, more than half of the world’s stock of money passes through offshore centers, about 20 percent of total private wealth is invested in these centers, and about 22 percent of banks’ external assets are invested offshore.
However, the role of OFCs began to be challenged in the 1980s. During the last 15 years, the financial industry has experienced massive deregulation--particularly in the OECD countries--capital and financial controls have been dismantled, markets opened, tax rates reduced, and international cooperation improved. As a result, the regulatory and fiscal environments of domestic financial centers have converged with those of offshore centers and significantly reduced the comparative advantages that OFCs once had. In addition, the importance of offshore centers diminished as international banks reduced their activities in the interbank markets, which represent the primary business of OFCs, and increased their involvement in derivative finance, which tends to be conducted in the major financial centers. Finally, the higher concentration of financial activity in a small number of large financial centers offering considerable economies of scale--deep and liquid markets, efficient clearing and settlement systems, and sophisticated technology--raised the cost of switching from major financial centers to OFCs.
In light of these trends, the recent proliferation of small offshore centers (for example, Dublin, Cyprus, Madeira, Malta, Malaysia’s Labuan Island, and Bangkok’s International Banking Facility) is unlikely to result in a proportionate increase in demand for their services. In the current liberalized and highly competitive environment, offshore centers will have greater difficulty in attracting financial activities away from the major financial centers.