Determinants of the Status of an International Financial Centre

• Author: Riley Jiang,Larry Li,Imad Moosa
• Date: 01 December 2016
• DOI: http://doi.org/10.1111/twec.12369
• Published date: 01 December 2016

Determinants of the Status of an

International Financial Centre

Imad Moosa, Larry Li and Riley Jiang

School of Economics, Finance and Marketing, RMIT University, Melbourne, Australia

1. INTRODUCTION

THE term ‘international financial centre (IFC)’ is used to describe a location where interna-

tional financial operations are conducted on a large scale. An IFC is characterised by

agglomeration of financial institutions providing financial services on an international level.

Definitions of an IFC can also be found in the literature on economic and financial geography

and history. For example, Cassis (2010, p. 2) defines a financial centre as ‘the grouping together,

in a given urban space, of a certain number of financial services’, or (in a more functional way)

‘the place where intermediaries co-ordinate financial transactions and arrange for payments to

be settled’. He then distinguishes among national, regional and international financial centres on

the grounds that the concentration of financial services can be found at ‘national, regional and

world level, depending on the extent of the geographical area served by one financial centre or

another’.

1

Jao (1997, p. 3) defines an international financial centre as a ‘place in which there is

a high concentration of banks and other financial institutions, and in which a comprehensive set

of financial markets are allowed to exist and develop, so that financial activities and transactions

can be effectuated more efficiently than at any other locality’.

The taxonomy of financial centres is taken further by the Z/Yen Group (2007), which clas-

sifies financial centres into five categories: (i) global financial centres, which require criteria

that are satisfied by London and New York only; (ii) international financial centres where a

significant volume of cross-border transactions are conducted; (iii) niche financial centres,

such as Zurich in private banking; (iv) national financial centres that act as hubs for financial

services within one country; and (v) regional financial centres that conduct a large proportion

of regional business within one country. Park (2011) distinguishes between an international

financial centre and a domestic one on the following grounds: (i) international centres deal in

various major currencies of the world, not just the currency of the country where a centre is

located; (ii) most of the financial transactions conducted in foreign currencies in international

centres are generally free of taxes and exchange controls; and (iii) international financial cen-

tres provide various financial services to both resident and non-resident clients.

Interest in the study of IFCs stems from their perceived contribution to economic activity

worldwide via several channels (Hines, 2009). These channels include the following: (i) they

play a role in stimulating foreign direct investment in high-tax locations; (ii) they discipline

financial markets in other parts of the world, limiting the degree to which banks and other

financial institutions can exploit local monopolies to the disadvantage of individuals and busi-

nesses; (iii) they promote good government and the benefits that flow from democratic

accountability (the evidence indicates that by far the most successful international financial

We are grateful to an anonymous referee for detailed and useful comments on earlier versions of this

paper.

1

The geography of finance is dealt with comprehensively by Clark and Wojcik (2007).

©2015 John Wiley & Sons Ltd

2074

The World Economy (2016)

doi: 10.1111/twec.12369

The World Economy

centres are those whose governments score highly on the World Bank’s indicators of gover-

nance quality); (iv) they exert an impact on tax collections and tax competition among big

countries; and (v) IFCs as a group have enjoyed rapid economic growth in the last 25 years,

reflecting in part the growing importance of financial sectors of modern economies, and in

part the special roles played by IFCs.

2

Hines (2009, p. 13) also argues that, contrary to com-

mon belief, ‘the transparency and accountability of IFC governance structures may seem

inconsistent with their reputations as locations of choice for money launderers, tax evaders,

and others seeking to establish anonymous accounts in which to hide assets from others’. He

points out that IFCs adhere rather strictly to international norms requiring ample documenta-

tion in order to create corporate entities and bank accounts, making them unattractive loca-

tions for money laundering and tax evasion. On the other hand, international financial centres

may be a source of financial instability. For example, Wojcik (2013. p. 1) argues that the glo-

bal financial crisis originated to a large extent in the ‘New York-London axis’, pointing out

that ‘the debate on global financial reform has to take seriously the reality of global financial

centres’ and that ‘if global finance is to change, the New York-London axis has to change’.

3

A question arises here as to what makes New York and London the top-ranked interna-

tional financial centres. In more general terms, what determines the status of an international

financial centre? Kawai (2009), for example, identifies some of the determinants of the sta-

tus of an IFC, including the economic power of the host country, the competitive environ-

ment for financial intermediation, financial stability, availability of skilled labour force,

high-quality infrastructure and appropriate business environment. Likewise, Fakitesi (2009)

lists some of the characteristics of an international financial centre as follows: (i) it is con-

ducive to the conduct of international financial business profitably, easily and efficiently; (ii)

there is abundance of skilled management and intellectual talent covering business, finance

and interdependent services; (iii) it offers deep liquid and sophisticated capital markets and

world competitive tax and regulatory regimes with foreign investment and offshore business

flow; (iv) it can add significant value to financial services through a workforce that can

respond promptly and in an innovative manner; (v) it offers high-quality telecommunications

and IT capacity as well as educated, multilingual workforce; (vi) all facets of financial ser-

vices can be located efficiently; and (vii) it provides a convivial and alluring environment

for business.

Due to data limitations, most of the studies investigating the determinants of the status of

an international financial centre are descriptive –there are only a few formal empirical stud-

ies. A typical empirical study would involve a cross-sectional analysis of the relation between

the status of an IFC and its determining factors. A problem that is encountered in cross-sec-

tional studies in general arises from the sensitivity of the estimated coefficients with respect

to model specification because no single theoretical model can be used to identify an explicit

2

This view can be disputed on the grounds that it was excessive financialisation of the economy that

led to the global financial crisis and great recession. The US and UK (homes to the number one and

number two IFCs) were more severely dented by the global financial crisis than Germany, which does

not appear in the top ten. However, as things stand in the third quarter of 2015, the US and UK

economies are growing more vigorously than continental European economies.

3

Those who are not as enthusiastic as Hines (2009) about the positive role played by IFCs observe that

three recent scandals took place in London: the LIBOR scandal, manipulation of precious metal prices

and rigging the foreign exchange market. Like Wojcik (2013), many scholars and observers do not hold

sanguine views about the contribution of international financial centres.

©2015 John Wiley & Sons Ltd

DETERMINANTS OF AN IFC 2075