Banking and Finance in Islands and Small States

Michael Bowe, Lino Briguglio, James W. Dean

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781317741046
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This collection of essays analyzes the special characteristics of the banking and financial sectors in islands and small states, and focuses on three main areas: the general financial environment; offshore financial centres; and banking and financial regulation. The main emphasis is on territories where banking and financial activity make a substantial contribution to gross domestic product.

1

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Financial Services Location and Competition among Financial Centres in Europe

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Mervyn K. Lewis

Competition among financial centres in the European time zone is often depicted, misleadingly, as a battle between London, Paris and, most recently, Frankfurt. This is misleading because it ignores the role of other locations and the nature of financial services operations. There are important national and regional centres in many countries, and also major specialist centres, such as Luxembourg, Edinburgh and Dublin along with the islands and small states such as the Channel Islands, Isle of Man, Liechtenstein, Malta and Monaco. These centres focus on particular activities such as offshore fund management, tax and financial planning, and the provision of a range of ancillary services complementary to other operations including group treasury, insurance and collective investments for the firms in the principal centres. As such, these centres are in direct competition not just with each other but with the international, national and regional locations.

In examining the nature of this competition, this chapter presents a schematic account of the financial firm, in which six core activities – financial packaging, delivery systems, production activities, regulation, management information systems and market interface – are seen to categorize the provision of financial services. These various components used to be carried out in the one location, but market and technological advances in recent decades have made it possible for them to be geographically separated. It is this ability to shift particular services and parts of the production process to different locations which makes for the complexity of financial services location decisions.

The Location of Finance

Location decisions in finance are made by financial enterprises engaged in the provision of financial services, and these location decisions govern the business in financial centres. Our starting point has to be the structure of the financial firm, and Figure 1.1 depicts some of the processes involved in the provision of financial services, in terms of six elements.

1. Financial instruments and claims provided to customers can be regarded as packaging together a number of financial characteristics: currency, term to maturity, interest rate structure, embedded options, counterparty risk, tax obligations.

2. Delivery or front-office activities involve contact with the customer and often require intensive use of human resources when financial products are ‘sold’ rather than ‘bought’. Included in this category are stockbroking and bond transactions, credit evaluation, syndication, investment management.

3. Back-office or production activities are processes of a repetitive nature such as transactions processing, loan application processing and servicing, credit accounting, custodial services.

4. Regulatory environment denotes that this production takes place within an economic setting under a set of regulatory rules and conventions, information provision, taxation arrangements, and political and currency stability.

5. Management information systems embrace human resource management, inventory control, strategic planning, cost control and profitability analysis, risk exposure and management, treasury operations.

6. Market interface involves access to news and market information services, and use of accounting and legal services, while provision of payment services by banks relies upon correspondent arrangements and inter-bank cooperation through the clearing house.

Figure 1.1 Representation of financial services operations

Types of centre

In the traditional pattern of financing, these elements were combined and were location-specific. Traditional centres, as emphasized by Kindleberger (1974), rose on the back of international trade (London, New York, Chicago, Frankfurt, Hong Kong) and/or balance of payments surpluses (Japan, Switzerland and Germany). The modern pattern of finance has cut these links. It has done so by separating the various elements geographically. As a result, production can be geographically separated from delivery, arranging from legal booking, market interface from portfolio management, support systems from customer servicing. In the process the geography of finance is reshaped. This geographical separation and conversion of location-specific services into ‘long-distance’ services is not dissimilar to the ‘splintering’ or ‘disembodiment’ of services analysed by Bhaghwati (1984) in another context. Technology has played a part in all of this, but so have taxation, regulations and other costs governing the provision of financial services.

Dufey and Giddy (1978) distinguished three types of centre: capital-exporting centres, the main role of which is to transfer overseas surplus domestic savings in the traditional way;entrepôt centres, which intermediate between international borrowers and lenders and also between international and domestic entities; and offshore centres, where intermediation is specifically for non-residents. Based on ‘splintering’ since then, a further distinction is drawn here in terms of market centres, where there is a concentration of trading in particular markets instruments, and ancillary centres, which attract various ancillary and support services from the major centres.

Traditional versus Euro centres

Until the 1960s, banks conducted international banking from their home bases. With only minor exceptions, the location of banking and the currency of denomination were inseparable: banking was a natural monopoly of the banks located in the country issuing the currency used for borrowing and lending. Deposits were taken from foreigners, and lending to foreigners occurred, in the currency of the country in which the main offices of banks were located. Much international banking is still carried out in this traditional way. However, only 16 per cent of international bank lending is ‘booked out’ in this traditional fashion (see Table 1.4 on page 22). Most international lending is instead externalized in the Eurocurrency centres, severing the nexus between the location of financial centres and the currency of lending. Before, the major centre (London, New York) was determined primarily by which country had the largest amount of capital for export. London was able to survive the ‘dollar hegemony’ because of the innovation of the Eurodollar market. In much the same way, London survived the growth of Japanese and German capital exports during the 1980s because of the rapid expansion of the Eurobond market and because of new instruments which blurred the traditional distinctions between international banking and bond markets.

By separating the location of banking from the currency used for borrowing and lending, the Eurocurrency system also separated currency (exchange rate) risk from political risk. In this respect, it altered the financial package in a fundamental way. A depositor holding dollar balances in a country other than the United States combines the currency risk of holding US dollars with the political risk of the particular country (the United Kingdom, Belgium, Singapore, etc.) which is host to the dollar operations. This ‘essential feature’ was instrumental in the origins of Eurocurrency operations. But growth during the 1960s and 1970s owed more to economic than political factors, for banking had also been separated from the economic risk of taxes and duties levied by the country issuing the currency of denomination. Taxation and economic controls widened the demand for financial services in less regulated locales, while on the supply side banks and other financial intermediaries found that wholesale financial services could be produced externally and delivered ‘on the wire’.

This trend to global deposit sourcing and lending in the Eurocurrency markets saw the rise of London and other European cities as international financial centres despite their having relatively weak domestic currencies and lack...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Contributors
• Preface
• Introduction
• 1 Financial Services Location and Competition among Financial Centres in Europe
• 2 Financial Deregulation and Offshore Banking: Lessons for Malta from Australasian/Asia-Pacific Experience
• 3 Labuan, Malta and Belize: Evolution of Three Small Offshore Banking Centres
• 4 Banking, Finance and Offshore Banking Activities in the Island of Mauritius
• 5 Mapping the Minefield: Theories of Island Offshore Finance Centres with Reference to Jersey
• 6 Offshore Finance Activities in Vanuatu: an Empirical Study of Determinants and Growth
• 7 Analysing the Emergence of an Offshore Banking Centre: the Case of Bahrain
• 8 Sovereignty, Security, and the Development of Offshore Financial Centres in the Pacific Islands
• 9 Majoring in Finance: Implications and Key Issues
• 10 The Impact of International Companies on the Economies of Small Islands: a Case Study of Bermuda
• 11 The Liberalization of Interest Rates in Malta: Policies and Strategic Options
• 12 The Money Supply Process in Two Small Island States: Malta and Cyprus, 1960-1993
• 13 International Banking and Securities Market Regulation: an Analysis of Recent Approaches
• 14 The Proposed Additional Capital Requirements for the Management of Banks' Interest Rate Risk
• 15 The 'OECD Club Rule' in Bank Risk-based Capital Adequacy: Implications for Malta and Other Small States
• Name Index
• Subject Index