draining development.pdf - Khazar University

Tax Havens and Illicit Flows 349(see Williamson and Mahar 1998). Over a quarter of a century or more,the richer economies engaged in competitive deregulation of financialmarkets. Secrecy jurisdictions took this to an extreme, exploiting thegaps left by the national regulation of global finance.The key regulatory arbitrage occurred around the regulation of banksand other financial institutions, particularly regulation that, to protectdepositors from undue risk, limits the amount of assets banks may acquireas a proportion of their own capital base. The Basel II capital accord allowsassets of US$1,250 for each US$100 of capital. In merely one example ofan excess, Stewart (2008) has discovered that the Irish holding company ofthe now-collapsed U.S. bank Bear Stearns held US$11,900 in assets foreach US$100 of capital. The late-2011 collapse of broker-dealer MF Globalrevealed a ratio in excess of 80:1 (Christian Aid 2011).The crisis was driven by two key factors that allowed an unsustainableexpansion in credit. One was the complexity of the new financial instruments,which confused investors and regulators about the true ownershipof assets and liabilities. The other was the opacity of the shadow bankingsystem, that is, financial activities outside the traditional banking system,from hedge funds and private equity to the structured investment vehiclesand other conduits of investment banks and others, all taking advantage ofregulatory arbitrage to operate through secrecy jurisdictions.U.S. Treasury Secretary Timothy Geithner (then president of the NewYork Federal Reserve Bank) has estimated that only a portion of theseactivities exceeded the total assets of the entire U.S. banking system:“Financial innovation made it easier for this money to flow around theconstraints of regulation and to take advantage of more favorable taxand accounting treatment” (Geithner 2008, 1).The genesis of the crisis was undoubtedly complex, and attempts tostrictly apportion blame are likely ultimately to be futile. It does seem clear,however, that the role of secrecy jurisdictions was nonnegligible at theleast. An important policy response to the specific problems posed by regulatoryarbitrage was the decision by G-20 finance ministers in September2009 to call for “the setting of an overall leverage ratio, which will take intoaccount off-balance-sheet activities, in order to limit the amount of borrowingconducted by institutions outside the formal banking regime.” 12While researchers will continue for many years to reexamine the genesisof the crisis and the long period of deregulation and liberalization