Fragile Renegades: Offshore Banking Centers in the Global Financial Crisis

Abstract

Lying at the heart of offshore finance is a basic contradiction. On the one hand, offshore finance is fundamentally driven by the desire to protect private property from the state; on the other hand, this property is itself ultimately dependent on the protection of the state. This dilemma has recently been highlighted by crises in Iceland, Ireland, and Cyprus in particular; however, there has to date been no systematic research into its implications for the stability of the global offshore system. Here we seek to fill this gap, by theoretically and empirically problematizing the geographically uneven impact of the global financial crisis on the worldwide offshore banking network. Our results indicate that the shift from territorial to nationality-based regulation under Basel encouraged a shift, in the 1990s and early 2000s, from risk-externalizing to risk-internalizing offshore banking center development. This saw a relative decline in the traditional staple of foreign bank booking — wherein the costs of backstopping a potential crisis were shifted to other states — and a concomitant growth of national banks backstopped by offshore states themselves. This growth interacted with the international geography of currency usage to produce an uneven pre-crisis landscape of offshore banking vulnerability, which materialized following the shock of the global financial crisis. In the aftermath of the crisis, the most resilient offshore centers were those which had either: 1) preserved the traditional foreign bank booking model, 2) pursued a “state capitalist” offshore banking model, wherein national bank foreign currency liabilities are hedged by sovereign foreign currency reserves, or 3) developed an exceptionally diverse and robust network of foreign funding sources.

Keywords: Offshore financial centers, international banking regulation, global financial crisis, Eurozone crisis, lender of last resort, currency denomination, globalization, state sovereignty

JEL Classification: E58, F34, F65, G28, H63, H81