ABSTRACT
This chapter analyses one of the most important 'proximate' causes of the development of the shadow banking system. It describes that shadow banking entities and transaction structures that have developed in and around them are deeply linked to the tax and regulatory flexibility they offer to companies, financial institutions and individuals. The chapter presents some of the evidence that suggests that the key instruments of the shadow banking world, derivatives, SPVs and hedge funds, are motivated at least to a degree by tax avoidance, or what the industry would term tax and regulatory arbitrage. For most of the twentieth century, economic paradigms and regulatory frameworks have been built on the clear separation of national and international jurisdictional space, and within nations, between fiscal and financial phenomena. In the early phase of the development of derivatives, researchers seemed to be very aware of the tax advantages offered by such transactions and their role in international capital flows.
