Capturing banking flows: The predominant role of OFCs in the international financial architecture

This issue of Economic and Financial Debates provides new insights on offshore financial centers (OFCs) and their role in the international financial system. We first develop a statistical methodology to identify and quantify the importance of these OFCs as counterparties in the total of cross-border banking positions, based on international banking data. This allows us to establish a list of OFCs based on objective and transparent statistical criteria. A list of 13 countries/jurisdictions is derived from this work. We subsequently compute an indicator measuring the degree of extraterritoriality for each banking system based on the OFC list previously compiled in order to quantify their importance in the international financial architecture. It appears that the banking system of a reporting country holds, on average, 1/5 of its asset positions on entities resident in OFCs and receives 1/6 of its liability positions from entities resident in OFCs. Should the scope be limited to interbank positions only, this ratio is 15% on both asset and liability sides. The French banking system is at the median of global distribution and slightly below it compared to banking systems of similar maturity. Overall, the French banking system has more recourse to OFCs for funding purposes than for capital investment purposes and favors 5 OFCs among the 13 we identified. We conduct an analysis of cross-border banking flows during the major stress caused by the financial crisis in 2008 to better understand the financial stability issues raised by OFCs. On the one hand, the volatility of flows vis-à-vis OFCs is, on average, higher than or equal to that observed vis-à-vis major banking systems. On the other hand, the volume of flows to and from the OFCs is similar to those between the largest banking systems. The large volume and very significant volatility of these flows thus underline the financial stability challenges that OFCs are likely to raise. Finally, we apply a community detection method to the graph representing the interbank positions network in order to analyze the organizational pattern of banking systems interactions. Four communities emerge and indicate a very clear regionalization pattern whose perimeters reflect the importance of economic, commercial or geopolitical links in interbank links. The OFCs participate in this regionalization and are each integrated into the nearest geographical area. This integration has been taking place since 2003 and suggests that, despite the increasing interconnection of banking systems, OFCs retain a form of geographical specialization.