Dublin’s shadow banks


5. Tax havens allow banks to dodge financial rules and regulations

For example

… Dublin, where “light touch regulation” draws in money from far and wide and channels it directly into the shadow banking system.

The dirty details

Shadow banks sound like something you’d come across in a Harry Potter novel, nestled alongside Gringotts somewhere down Diagon Alley. In the slightly (only slightly) less exciting realities of the financial world, the term “shadow banks” refers to financial organisations who provide banking-type services but without being regulated like traditional banks.[1]

Like Potter’s world, however, the shadow banking system is filled with practices that muggles* cannot begin to comprehend. More disturbingly, at the heart of both lies a strong, evil presence that must be confronted if harmony is to be restored.

Over the past fifteen years or so, the shadow banking system has boomed as a range of new players has emerged in the international financial system.[2] This process of financial “innovation” has seen the establishment of hedge funds and investment banks alongside more obscure products, which are created by financial organisations – notably banks – but done so off their books.[3]

The key thing to remember is that this ‘innovation’ – involving an explosion of lending and credit – has been driven by the desire to avoid regulation and tax. But regulation exists for a reason and a very good one at that: “bank failure can damage a whole economy, and cause systemic damage on a global scale. Numerous banks are now at risk”, write financial experts Nicholas Shaxson and John Christensen.

With the onset of the global financial crisis from 2008 onwards, it became clear just how problematic these risk-taking innovation strategies had been. So why wasn’t any significant official attention paid to the shadow banking system up until this point? The answer is simple; extensive use of tax havens shielded the extent of the crisis from most of those who should have known better. Dublin is a perfect case in point. As competition between financial centres has increased, growing numbers of jurisdictions – Ireland most certainly included – have been “streamlining” regulation to attract funds.[4] The result is that Dublin’s principle attraction today, above and beyond its low-tax regime, is its light touch regulation.

In principle, the Irish Financial Services Regulatory Authority – the sole regulator of all financial institutions in Ireland from May 2003 until October 2010[5] – was supposed to oversee the financial transactions of companies and banks located in Ireland. In practice, as the 2007 collapse of global investment bank Bear Stearns demonstrated, the Irish Financial Regulator’s presence was minimal to non-existent. Despite substantial operations carried out by Bear Stearns in Dublin, the Irish regulator does not feature in any media analysis or discussions relating to the insolvency and subsequent take-over of the company.[6] This, ladies and gentlemen, is the shadow banking system, (Hog)warts and all.

*muggles = (noun) A person who possesses no magical skills or abilities.

Solutions

Global regulatory standards must be agreed and enforced to prevent tax havens from undermining regulation elsewhere and precipitating a race to the bottom. Tax havens that fail to conform should be blacklisted and identified as high risk locations.

International accounting standards should require full ‘on balance sheet’ disclosure of all risks across the entire structure of all licensed banks. These risks should be audited by independent audit firms and assessed by independent credit rating agencies.

Key statistic

The total amount of money managed by offshore financial organisations located in the IFSC [Dublin's International Financial Services Centre], much of it channelled through obscure conduits, quadrupled between 2000 and 2006 to nearly 1.6 trillion euros – more than ten times as much as real foreign direct investment in Ireland.[7]

The final word

From Bill Gross, founder of the US financial firm Pimco[8]:

The shadow banking system has lain hidden for years, untouched by regulation, yet free to magically and mystically create and then package subprime loans into a host of three-letter conduits that only Wall Street wizards could explain.

References

[1] http://www.taxjustice.net/cms/upload/pdf/Troost-Liebert_tax_havensfinancial_crisis.pdf [accessed 7/11/11] p.2.
[2] http://www.taxjustice.net/cms/upload/pdf/TJF_4-2_AABA_-_Research.pdf [accessed 7/11/11] p.1.
[3] http://www.taxjustice.net/cms/upload/pdf/TJF_4-2_AABA_-_Research.pdf [accessed 7/11/11] p.1.
[4] http://www.taxjustice.net/cms/upload/pdf/TJF_4-2_AABA_-_Research.pdf [accessed 7/11/11] p.2.
[5] http://www.ifsc.ie/company.aspx?idcategory=35&idcompany=127 [accessed 8/11/11] and http://www.centralbank.ie/about-us/Pages/default.aspx [accessed 8/11/11].
[6] http://www.taxjustice.net/cms/upload/pdf/TJF_4-2_AABA_-_Research.pdf [accessed 7/11/11] p.3.
[7] http://www.taxjustice.net/cms/upload/pdf/Troost-Liebert_tax_havensfinancial_crisis.pdf [accessed 7/11/11] p.7.
[8] http://www.taxjustice.net/cms/upload/pdf/TJF_4-2_AABA_-_Research.pdf [accessed 7/11/11] p.2.