It Takes Two to Tango: International Financial Regulation and Off-Shore Centres

Abstract

The paper aims at shedding some light on the dynamics of competition among off-shore centers that attract capitals of illicit origins. The paper takes a relational approach, focusing on the relations established between off-shore centers and criminal organizations, in order to design the optimal international financial regulation. The main problem faced by off-shore countries is one of devising a credible commitment not to behave opportunistically ex post the exchange with criminal organizations. More specifically, off-shore centers need to post a "hostage" that increases criminal organizations' trust in the exchange. This result is ensured by a solid reputation as a supplier of criminal financial services and by dependence on revenues generated by money laundering.

In a world of bounded rationality, contracts are hopelessly incomplete. Ex post mechanisms of governance of the relations are pivotal. Keeping the quality of regulation constant, off-shore centers that will be able to offer gap filling devices of superior quality will be in an advantageous position. The paper focuses on one of such devices, i.e. an efficient judiciary.

The paper derives some implications for devising an international response to the threat posed by such countries. On a battleground where reputation is a fundamental weapon, a per se "name and shame" approach may even prove counterproductive. It may in fact increase the transaction specific nature of investments in reputation, thus cementing the commitment of off-shore centers. Names should be named, but only if blacklisting goes hand in hand with other appropriate countermeasures. The paper also argues that, due to the perverse nature of competition among off-shore centers, countermeasures should be aimed at skimming off the most important suppliers, rather than trying to hit in a non discriminating way all countries in the market.

Keywords: Off-shore centers, international financial regulation

JEL Classification: G15, G18, G20