Treasure Islands - Nicholas Shaxson [47]
A quick numerical exercise shows how unregulated offshore finance can be so profitable, far beyond the potential merely for eliminating taxes.
Governments require banks to hold reserves against the deposits they take. Let’s imagine a bank officially has to hold 10 percent of the value of its deposits in cash, and the going interest rate is 5 percent annually for loans and 4 percent for deposits. For every $100 deposit, the bank may only lend $90 at 5 percent, earning it $4.50. The bank must pay the depositor 4 percent, leaving it 50 cents. Subtract the bank’s operating costs of, let’s say, 40 cents, and it has made 10 cents’ profit on its $100 in deposits.
Now imagine, instead, a bank in the Euromarkets in London, which has no reserve requirements. The bank can now lend all of its $100 at 5 percent, earning $5. Subtract $4 to pay interest to the depositor, then subtract 40 cent operating costs, and the profit now is 60 cents—six times the “onshore” profits. This is grossly simplified, but it exemplifies a basic principle behind offshore’s appeal. On the face of it, this looks like a cost-free benefit for everyone: In a competitive market, the bankers will pass some of those profits on to borrowers and depositors. But this is a false view. First, much of the profit will pass to the bank’s wealthy owners, and to the extent that the banks do pass on these savings, offshore customers will almost always be the world’s wealthier citizens and corporations. Second, the increased profits come at a cost: increased risk. The latest financial crisis has showed what happens when such risks materialize: ordinary people pay. Free money for bankers and for the world’s wealthy—at the expense of everyone else—is a basic leitmotif of the offshore system.
There is another offshore secret at play here too. It hinges around why banks have to hold reserves against deposits in the first place.
Imagine you deposit $100 with an “onshore” bank. Under a 10 percent reserve requirement, the bank may lend out only $90 of that to someone else. That person now has $90 to spend, and that $90 will end up in another bank account. That next bank may then lend 90 percent of that $90 out—so $81 more will end up being lent. And the process goes on. This is a well-known principle of so-called “fractional reserve banking,” and if you follow the calculations through you will find that with a 10 percent reserve requirement your $100 theoretically balloons out into $1,000, spread across the economy. Money really is conjured out of thin air like this: This is what banks do. Money is created by the act of lending it. “The process by which money is created is so simple that the mind is repelled,” said the economist J. K. Galbraith. Money creation is not a bad thing in itself. The question is: how much borrowing, and how much money creation, is healthy? Regulators try to control liquidity—making sure that the amount of money sloshing around the system does not grow out of control—by enforcing reserve requirements.
But in the unregulated London-based Euromarkets, with no reserve requirements, the first $100 deposit theoretically lets the bank lend out the full $100, which turns into another $100