Because the home country is not required to reimburse foreign depositors for losses, there is no corresponding financial penalty for lax supervision; there is, though, a benefit to the country with lenient regulatory policies because of increased revenues generated and the employment opportunities these services provide (Edwards 1999). Furthermore, banks seeking to conduct multinational business are attracted to countries where incorporation laws and the regulatory framework offer less regulatory oversight (Edwards 1999). The quid pro quo nature of offshore financial services is clearly indicated by Edwards's observation that, "Multinational banks provide the offshore financial centre with increased tax revenue and employment for its citizens. Because the benefits outweigh the costs, offshore financial centres have a powerful incentive to maintain lenient regulatory policies. As a result, multinational banks incorporated in an offshore financial center successfully avoid supervision by an effective home country regulator" (1999, p. 1267). Given the scope of the offshore financial services sector at present and predictions for continued growth in the future, this type of study is clearly important by establishing an overview and "snapshot" of the industry as it exists today, as well as benchmarks that can be used for future comparisons.
Scope of Study
Based on the nature of the offshore financial services sector, the scope of the study extended to its global implications, with a specific focus on its effects on taxation and the global economy.
Rationale of Study
The research will show that notwithstanding their exploitation by criminal elements and terrorist organizations, offshore financial centres are not expected to go away anytime soon. The importance of the legitimate financial transactions that take place in offshore financial centres to the global economy make them an important addition to the international community and restrictions on the industry or its outright eliminated (if that was even possible) would have dire consequences for the global economy. According to Mckee, Garner and Mckee, "Through the activities they house, [offshore financial centres] are actually facilitators of various international activities. Indeed it appears as though the leading participants in the global economy, whether corporate or public, are in need of various services provided by or through offshore financial centers" (2000, p. 3). In this environment where each positive is balanced by a corresponding negative, identifying opportunities to eliminate the abuse of offshore financial centres by criminals and terrorists while improving their ability to provide vital legitimate financial services to the international community represents a timely and valuable enterprise.
Overview of Study
This study used a four-chapter format to achieve the above-stated research purpose. chapter one introduced the topic under consideration, a statement of the problem, the purpose and importance of the study, as well as its scope and rationale. Chapter two provides a critical review of the relevant and peer-reviewed literature, and chapter three provides an analysis and discussion of the findings that emerged from the review of the literature. Chapter four presents the study's conclusions and a summary of the research.
Definitions of Key Terms
Definitions of the key terms, abbreviations and acronyms that were used in this study are presented in Table 1 below.
Definitions of Key Terms
Customer due diligence
Basel Core Principles
Financial Action Task Force
Financial intelligence unit
Financial Stability Forum
International Finance Corporation
International Monetary Fund
Know your customer
Multilateral Investment Guarantee Agency
Organization for Economic Cooperation and Development
Offshore financial centre
World Bank Group
Chapter 2: Review of Related Literature
Background and Overview
Although there is no universal definition of offshore financial centre, a number of such definitions have been offered over the years. According to Mauer, "There is a significant literature on the dimensions and definitions of the offshore finance industry. The first definitional quandary is whether offshore refers to a place or series of places on the one hand, or a phenomenon of financial flows on the other hand" (2008, p. 155). The legal definition provided by Black's Law Dictionary (1999) indicates that offshore transactions are financial dealings that occur outside of a given country. A more useful definition, though, is provided by the International Monetary Fund (IMF) which reports that, "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" (Offshore financial centers 2000, p. 2). There are some other ways to formally distinguish offshore financial centres as well. For example, an offshore financial centre is an area officially designated by the IMF as being a place where the following types of activity take place: offshore banking, investment, incorporation, company formation, foundation formation, trust formation, insurance and other vehicles of wealth preservation and asset protection; the criteria required to be placed on the official list maintained by the IMF are as follows:
1. Have relatively large numbers of financial institutions engaged primarily in business with non-residents; and,
2. Have financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economies (Mauer 2008).
Offshore financial centres must provide some or all of the following services:
1. Low or zero taxation;
2. Moderate or light financial regulation;
3. Banking anonymity (Definition of Offshore Financial Centers 2011).
The IMF also reports that offshore financial institutions can also assume the form of accepting deposits from individuals and taking those proceeds and investing them in other financial markets (Offshore financial centers, 2000). Some regions of the world appear to attract more of this type of business than others. For instance, according to Stessens (2000), numerous Caribbean jurisdictions are frequently identified as both secret and tax havens; however, this type of identification can also be applied to financial services centres located in Andorra, Malta, Channel Islands, Liechtenstein, Monaco, Madeira, Gibraltar, Switzerland and Luxemburg, countries and territories that are also described as being offshore financial centres; these jurisdictions are also categorized as being "fiscal havens" by the U.S. Internal Revenue Service (Stessens 2000). "In the context of financial transactions," Stessens adds, "the term 'offshore' refers to transactions which take place between non-residents. An offshore bank can be defined as a financial institution which is legally domiciled in one jurisdiction, but conducts business solely with non-residents" (2000, p. 93). Other formal definitions of offshore financial centres have been offered by authorities such as Jao, who reports that, "By general agreement, an 'offshore financial centre' or, more narrowly, an 'offshore banking center' is a center where the host country accords preferential treatment to banks and other financial institutions in terms of taxation, regulatory restrictions, prudential supervision, and so on, provided that such banks and financial institutions deal only with nonresidents and in foreign currencies and are thus effectively insulated from the host country's domestic financial sector" (2001, p. 45). According to Stessens, though, "By this definition 'offshore transactions' can take place in any jurisdiction, but as a result of their fiscal and secrecy rules, some jurisdictions attract a very high number of offshore transactions and offshore banks and have thereby become known as offshore financial centres" (2000, p. 93).
Clearly, though, there is sufficient evidence available that indicates money launderers frequently use offshore financial centres to conceal the proceeds of criminal activities or legitimate earnings to avoid taxation on their revenuel. As Stessens observes, "In both instances they are likely to benefit from the secrecy rules and from the inertia of local law enforcement or fiscal authorities or their refusal to reply to requests for information" (2000, p. 93). Efforts to address the illegal activities that have taken place in offshore financial centres have been hampered by the increasing internationalization of the money laundering enterprise, and a broad-based and sustained effort is required by the international community in order to be effective at all (Stessens 2000). According to Stessens, "Strictly national interventions are likely to result only in a geographical shift of the phenomenon. Because of the increasing globalisation of the financial world, the proceeds of crime which have been deposited within one jurisdiction where the rules on the prevention of money laundering are less strict can penetrate into the financial system of other countries as well" (2000, p. 93). These jurisdictions fall within the global payments system but operate largely without any restrictions; to the extent that these jurisdictions avoid such restriction, they will continue to attract criminal and terrorist elements who want to take advantage of these lax banking systems (Stessens 2000).
Based on these foregoing definitions, it is clear that so-called "offshore transactions" can actually be conducted in…