Financial & Economic Crisis
Financial Crisis of 2008 in Iceland
Overview of the crisis
The 2008 Icelandic financial crisis is a major ongoing economic crisis in Iceland that involves the collapse of all three of the country's major banks following their difficulties in refinancing their short-term debt and a run on deposits in the United Kingdom. The financial crisis has had serious consequences to the Icelandic economy; the national currency has fallen sharply in value, foreign currency transactions have been virtually suspended, the market capitalisation of the Icelandic stock exchange has dropped by more than 75%, and a severe economic recession is expected.
In late September, it was announced that the Glitnir bank would be nationalised. The following week, control of Landsbanki and Glitnir was handed over to receivers appointed by the Financial Supervisory Authority (FME). Soon after that, the same organisation placed Iceland's largest bank, Kaupthing, into the receivership as well. Commenting on the need for emergency measures, Prime Minister Geir Haarde said on 6 October "There [was] a very real danger … that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could be national bankruptcy." He also stated that the actions taken by the government have ensured that the Icelandic state will not actually go bankrupt. At the end of the second quarter 2008, Iceland's external debt was 9,553 billion Icelandic krónur (50 billion euros), more than 80 percent of which was held by the banking sector. This value compares with Iceland's 2007 GDP of 1,293 billion krónur (8.5 billion euros). The assets of the three banks taken under the control of the FME totalled 14,437 billion krónur at the end of the second quarter 2008.
The full cost of the crisis cannot yet be determined, but already exceeds 30 percent of the country's GDP. Outside Iceland, more than half a million depositors, which far more than the entire population of Iceland, found their bank accounts frozen amid a diplomatic argument over deposit insurance. German bank BayernLB faces losses of up to €1.5 billion, and has had to seek help from the German federal government. The government of the Isle of Man will pay out half of its reserves, equivalent to 7.5 percent of the island's GDP, in deposit insurance.
Causes
The crisis came about gradually as banks became unable to refinance their debts. It is estimated that the three major banks hold foreign debt in excess of €50 billion, or about €160,000 per Icelandic resident, compared with Iceland's gross domestic product of €8.5 billion. As early as March 2008, the cost of private deposit insurance for deposits in Landsbanki and Kaupthing was already far higher, 6–8.5 percent of the sum deposited, than for other European banks. The króna, which was ranked by The Economist in early 2007 as the most overvalued currency in the world based on the Big Mac Index, has further suffered from the effects of carry trading.
Coming from a small domestic market, Iceland's banks have financed their expansion with loans on the interbank lending market and, more recently, by deposits from outside Iceland (which are also a form of external debt). Icelanders also took on a large amount of consumer debt, equivalent to 213 percent of disposable income, which led to inflation.
In response to the rise in prices—14 percent in the twelve months to September 2008, compared with a target of 2.5 percent—the Central Bank of Iceland has held interest rates high at 15.5 percent. Such high interest rates, compared with 5.5 percent in the United Kingdom or 4 percent in the eurozone for example, have encouraged overseas investors to hold deposits in Icelandic krónur, leading to monetary inflation: the Icelandic money supply (M3) grew 37.8 percent in the twelve months to August 2008, compared to 5.0 percent GDP growth. The situation was effectively an economic bubble, with investors overestimating the true value of the króna.
As with many banks around the world, the Icelandic banks found it increasingly difficult or impossible to roll over their loans in the interbank market, their creditors insisting on repayment while no other banks were willing to make fresh loans. In such a situation, a bank would normally have to ask for a loan from the central bank as the lender of last resort. However in Iceland the banks were so much larger than the national economy that the Central Bank of Iceland and the Icelandic government could not guarantee the repayment of the banks' debts, leading to the collapse of the banks. The official reserves of the Central Bank of Iceland stood at 374.8 billion krónur at the end of September 2008, compared with 350.3 billion krónur of short-term international debt in the Icelandic banking sector, and at least £6.5 billion (1,250 billion krónur) of retail deposits in the UK.
The situation was made worse by the fact that Icesave was operating as a branch of Landsbanki, rather than as a legally independent subsidiary. As such, it was completely dependent on the Central Bank of Iceland for emergency loans of liquidity, and could not turn to the Bank of England for help. The UK Financial Services Authority (FSA) was aware of the risk, and was considering imposing special liquidity requirements on Icelandic deposit-taking banks in the weeks before the crisis. However the plan – which was never implemented – would have forced the Icelandic banks to cut interest rates or stop taking new deposits, and might even have sparked the sort of bank run it was designed to prevent. The Guernsey authorities were also planning on bringing in restrictions on foreign banks operating as branches and on transfers of funds between Guernsey subsidiaries and parent banks referred to as "parental upstreaming". Landsbanki operated in Guernsey through a legally independent subsidiary.
The existence of a bank run on Landsbanki accounts in the UK in the period up to 7 October seems confirmed by a statement from the bank officials on 10 October, which said "Landsbanki Íslands transferred substantial funds to its UK branch during this time to fulfil its Icesave commitments." The transfer of funds from Landsbanki Guernsey to Heritable Bank, a Landsbanki subsidiary in the UK, also suggests a bank run in the UK. A transfer of "substantial funds" from Iceland to the UK would have been a significant downward push on the value of the króna, even before the effects of any speculation.
History of events
Iceland’s currency
The value of the Icelandic króna has declined significantly during 2008.The Icelandic króna had declined more than 35 percent against the euro between January and September 2008. Inflation of prices in the economy was running at 14 percent. Iceland's interest rates have been raised to 15.5 percent to deal with the high inflation, and the króna's decline is reportedly only beaten by that of the Zimbabwean dollar. This depreciation in currency value put pressure on the banking system, which were largely dependent on foreign debt.
On Wednesday night, 8 October, the Central Bank of Iceland abandoned its attempt to peg the Icelandic króna at 131 krónur to the euro after trying to set this peg on 6 October. By 9 October, the Icelandic króna was trading at 340 to the euro when trading in the currency collapsed due to the FME's takeover of the last major Icelandic bank, and thus the loss of all króna trade 'clearing houses'. The next day, the central bank introduced restrictions on the purchase of foreign currency in Iceland.
The Central Bank of Iceland set up a temporary system of daily currency auctions on 15 October to facilitate international trade. The value of the króna is determined by supply and demand in these auctions. The first auction sold €25 million at a rate of 150 krónur to the euro. Commercial króna trading outside Iceland restarted on 28 October, at an exchange rate of 240 krónur to the euro, after Icelandic interest rates had been raised to 18 percent.
Banking system
On 29 September 2008 a plan was announced for the bank Glitnir to be nationalised by the Icelandic government with the purchase of a 75 percent stake for €600 million. The government stated that it did not intend to hold ownership of the bank for a long period, and that the bank was expected to carry on operating as normal. According to the government the bank "would have ceased to exist" within a few weeks if there had not been intervention. It later turned out that Glitnir had US$750 million of debt due to mature on 15 October. However, the nationalization of Glitnir never went through, as it was placed in receivership by the Icelandic Financial Supervisory Authority (FME) before the initial plan of the Icelandic government to purchase a 75 percent stake had been approved by shareholders.
The announced nationalisation of Glitnir came just as the United Kingdom government was forced to nationalise Bradford & Bingley and to sell its retail operations and branch network to Grupo Santander. Over the weekend of 4–5 October, British newspapers carried many articles detailing the nationalisation of Glitnir and the high leverage of its other banks. Influential BBC business editor Robert Peston published an opinion piece on Iceland's banks, stating that debt insurance for Kaupthing, the largest bank in Iceland, required a premium of £625,000 to guarantee the return of £1 million: "the worst case of financial BO I've encountered in some time" was his graphic description. The Guardian said "Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland's currency, is in freefall". These articles spooked investors discussing Icesave (the brand name of Landsbanki in the UK and the Netherlands) in online forums and many started moving their savings out of the Internet bank. Problems with access to the site hinted at a run on savings.
On 6 October, a number of private interbank credit facilities to Icelandic banks were shut down. Prime Minister Geir Haarde addressed the nation, and announced a package of new regulatory measures which were to be put to the Althing, Iceland's parliament, immediately, with the cooperation of the opposition parties. These included the power of the FME to take over the running of Icelandic banks without actually nationalising them, and preferential treatment for depositors in the event that a bank had to be liquidated. In a separate measure, retail deposits in Icelandic branches of Icelandic banks were guaranteed in full. The emergency measures had been deemed unnecessary by the Icelandic government less than 24 hours earlier.
That evening, the Guernsey subsidiary of Landsbanki went into voluntary administration with the approval of the Guernsey Financial Services Commission. The administrators would later say that "The main reason for the Bank’s difficulties has been the placing of funds with its UK fellow subsidiary, Heritable Bank." Guernsey's Chief Minister stated "the directors of Landsbanki Guernsey took appropriate steps by putting the bank into administration."
The FME placed Landsbanki in receivership early on 7 October. A press release from the FME stated that all of Landsbanki's domestic branches, call centres, ATMs and internet operations will be open for business as usual, and that all "domestic deposits" were fully guaranteed. The UK government used the Special Provisions of the Banking Act 2008 first to transfer retail deposits from Heritable Bank to a Treasury holding company, then to sell them to Dutch bank ING Direct for £1 million.
That afternoon, there was a telephone conversation between Icelandic Finance Minister Árni Mathiesen and UK Chancellor of the Exchequer Alistair Darling. That evening, one of the governors of the Central Bank of Iceland, Davið Oddsson, was interviewed on Icelandic public service broadcaster RÚV and stated several times that "we [the Icelandic State] are not going to pay the banks' foreign debts".
The next day, the FME placed Glitnir into receivership. Alistair Darling announced that he was taking steps to freeze the assets of Landsbanki in the UK. Under the Landsbanki Freezing Order 2008, passed at 10 a.m. on 8 October 2008 to come into force ten minutes later, the Treasury went on to freeze the assets of Landsbanki and assets belonging to the Central Bank of Iceland, and the Government of Iceland relating to Landsbanki. The freezing order took advantage of provisions in sections 4 and 14 and Schedule 3 of the Anti-terrorism, Crime and Security Act 2001, and was made "because the Treasury believed that action to the detriment of the UK's economy (or part of it) had been or was likely to be taken by certain persons who are the government of or resident of a country or territory outside the UK."
The UK Prime Minister, Gordon Brown, announced that the UK government would launch legal action against Iceland over concerns with compensation for the estimated 300,000 UK savers. Geir Haarde said at a press conference on the following day that the Icelandic government was outraged that the UK government applied provisions of anti-terrorism legislation to it in a move they dubbed an "unfriendly act". The Chancellor of the Exchequer also said that the UK government would foot the entire bill to compensate UK retail depositors, estimated at £4 billion. It is reported that more than £4 billion in Icelandic assets in the UK have been frozen by the UK government. The UK Financial Services Authority (FSA) also declared Kaupthing Singer & Friedlander, the UK subsidiary of Kaupthing Bank, in default on its obligations, sold Kaupthing Edge, its Internet bank, to ING Direct, and put Kaupthing Singer & Friedlander into administration. Over £2.5 billion of deposits for 160,000 customers were sold to ING Direct. The scale of the run on Kaupthing Edge deposits had been such that many transactions were not completed until 17 October. Although Geir Haarde has described the UK government's actions over Kaupthing Singer & Friedlander as an "abuse of power" and "unprecedented", they were the third such actions taken under the Special Provisions of the Banking Act 2008 in less than ten days, after interventions in Bradford & Bingley and Heritable Bank.
On the same day, the Sveriges Riksbank, Sweden's central bank, made a credit facility of 5 billion Swedish krona (€520 million) available to Kaupthing Bank Sverige AB, the Swedish subsidiary of Kaupthing. The loan was for payment to "depositors and other creditors".
On 9 October, Kaupthing was placed into receivership by the FME, following the resignation of the entire board of directors. The bank officials said that it was in technical default on its loan agreements after its UK subsidiary had been placed into administration. Kaupthing's Luxembourg subsidiary asked for, and obtained, a suspension of payments (similar to chapter 11 protection) in the Luxembourg District Court. Kaupthing's Geneva office, which was a branch of its Luxembourg subsidiary, was prevented from making any payments of more than 5000 Swiss francs by the Swiss Federal Banking Commission. The directors of Kaupthing's subsidiary on the Isle of Man decided to wind up the company after consultation with the Manx authorities.
On the same day, the UK Treasury issued a licence under the Landsbanki Freezing Order 2008 to allow the London branch of Landsbanki to continue some business. A second licence was issued on 13 October, when the Bank of England provided a £100 million secured loan to Landsbanki "to help maximise the returns to UK creditors."
On 12 October the Norwegian government took control of Kaupthing's Norwegian operations, including "all of the bank's assets and liabilities in Norway."
On 21 October, the Central Bank of Iceland asked the remaining independent financial institutions for new collateral against their loans. This was to replace the shares in Glitnir, Landsbanki and Kaupthing which had been pledged as collateral previously and which were now of much lower value, if not worthless. The value of the collateral was estimated at 300 billion krónur (€2 billion). One of the banks, Sparisjóðabanki (SPB, also known as Icebank), stated the next day that it could not provide new collateral for its 68 billion krónur (€451 million) loan, and would have to turn to the government for help. "This problem won’t be solved in any other way," said CEO Agnar Hansson.
On 24 October, it emerged that Norway's semi-public export credit agency Eksportfinans had made a complaint to Norwegian police concerning the alleged embezzlement of 415 million Norwegian kroner (€47 million) by Glitnir since 2006. The Icelandic bank had acted as an agent for Eksportfinans, administering loans to several companies: however Eksportfinans alleges that, when the loans were paid off early by borrowers, Glitnir kept the cash and merely continued with the regular payments to Eksportfinans, effectively taking an unauthorized loan itself.
Stock market
Trading in shares of six financial companies on the OMX Nordic Iceland Exchange was suspended on 6 October by order of the FME. On Thursday 9 October, all trading on the exchange was frozen for two days by the government "in an attempt to prevent further panic spreading throughout the country's financial markets". The decision was made to do so due to "unusual market conditions", with share prices having fallen 30 percent since the start of the month. The closure was extended through Monday 13 October due to continuing "unusual market conditions".
The market reopened on 14 October with the main index, the OMX Iceland 15, at 678.4, compared with 3,004.6 before the closure. This reflects the fact that the value of the three big banks, which form 73.2 percent of the value of the OMX Iceland 15, had been set to zero. The values of other equities varied from +8% to –15%. Trading in shares of Exista, SPRON and Straumur-Burðarás (13.66% of the OMX Iceland 15) remains suspended. After a week of very thin trading, the OMX Iceland 15 closed on 17 October at 643.1, down 93% in króna terms and 96% in euro terms from its historic high of 9016 on 18 July 2007.
Sovereign credit ratings
The four credit rating agencies which monitor Iceland's sovereign debt all lowered their ratings during the crisis, and their outlook for future ratings changes is negative. The Icelandic government has a relatively healthy balance, with sovereign debt of 28.3 percent of GDP and a budget surplus of 5.5 percent of GDP in 2007.
In addition, the value of foreign currency bonds which mature in the remainder of 2008 is only $600 million, and foreign currency debt service in 2009 is only $215 million, well within the government's ability to pay. However the agencies believe that the government will have to issue more foreign currency bonds, both to cover losses as the banks' overseas operations are liquidated and also to stimulate demand in the domestic economy as Iceland goes into recession.
A team of experts from the International Monetary Fund (IMF) arrived in Iceland at the start of October 2008 for talks with the government. Industry Minister Össur Skarphéðinsson was said to be "favourable" to help from the IMF to stabilise the króna and to allow interest rates to be lowered.
On 7 October, the central bank of Iceland announced that they had been in talks with the Russian ambassador to Iceland, Victor I. Tatarintsev, over a €4 billion loan from Russia. The loan would be be given across three or four years, with an interest rate 30 to 50 points above LIBOR. Central Bank of Iceland governor Davíð Oddsson later clarified that the loan was still being negotiated. According to RÚV, Prime Minister Geir Haarde had been investigating the possibility of a Russian loan since the mid-summer. When questioned on the matter in a press conference, Geir Haarde said: "We have not received the kind of support that we were requesting from our friends. So in a situation like that one has to look for new friends."
A team of Icelandic negotiators arrived in Moscow on 14 October to discuss the possible loan. Russian deputy finance minister Dmitri Pankin said that "The meeting took place in a friendly atmosphere … We are working thoroughly on the issue to take a final decision". On the same day, the Central Bank of Iceland drew on its swap facilities with the central banks of Denmark and Norway for €200 million each. Iceland has swap facilities with the other Nordic countries for a total of €1.5 billion. Iceland is also seeking assistance from the European Central Bank (ECB): there is some precedent for the move, as the ECB already has currency swap arrangements with Switzerland, another non-member of the European Union.
On 24 October, the IMF tentatively agreed to loan €1.58 billion.
Bank restructuring
The Financial Supervisory Authority (FME) has acted to "ring-fence" the Icelandic operations of Landsbanki and Glitnir, stating its aim of "continued banking operations for Icelandic families and businesses." Nýi Landsbanki was set up on 9 October with 200 billion krónur in equity and 2,300 billion krónur of assets. Nýi Glitnir was set up on 16 October with 110 billion krónur in equity and 1,200 billion krónur of assets.
Talks with Icelandic pension funds to sell Kaupthing as a going concern broke down on 17 October, and Nýja Kaupþing was set up on 22 October with 75 billion krónur in equity and 700 billion krónur of assets.
The equity in all three new banks was supplied by the Icelandic government, and totals to 30 percent of Iceland's GDP. The new banks will also have to reimburse their predecessors for the net value of the transferred assets, as determined by "recognised appraisers".
Impact of the financial crisis of 2008
Within Iceland
The current economic climate in the country has affected many Icelandic businesses and individuals. With the creation of Nýi Landsbanki, the new organisation which replaces the old Landsbanki, around 300 employees will lose their jobs due to a radical restructuring of the organisation which is intended to minimise the bank's international operations. Similar job losses are expected at Glitnir and Kaupthing. The job losses can be compared with the 2,136 registered unemployed and 495 advertised vacancies in Iceland at the end of August 2008.
Other companies have also been affected. For example, the private Sterling Airlines declared bankruptcy on 29 October 2008. The other national airline Icelandair has noticed a significant slump in domestic demand for flights. However, the airline states that year-on-year international demand is up from last year. Guðjón Arngrímsson, a spokesman for the airline, said "we're getting decent traffic from other markets... we are trying to let the weak [króna] help us." He has also stated that it is impossible to predict whether the company will make any profit this year. Morgunblaðið, an Icelandic newspaper, is cutting some jobs and merging parts of its operations with the media corporation 365. The newspaper 24 stundir has ceased publication due to the crisis, resulting in the loss of 20 jobs.
Importers are particularly hard hit, with the government restricting foreign currency to essential products such as food, medicines and oil. The €400 million loan from the central banks of Denmark and Norway is sufficient to pay for a month's imports, although on 15 October there was still a "temporary delay" which affected "all payments to and from the country".
The assets of Icelandic pension funds are, according to one expert, expected to shrink by 15–25 percent. The Icelandic Pension Funds Association has announced that benefits will in all likelihood have to be cut in 2009. Iceland's GDP is expected by economists to shrink by as much as 10 percent as a result of the crisis, putting Iceland by some measures in an economic depression. Inflation may climb as high as 75 percent by the end of the year.
Outside Iceland
Over £840 million in cash from more than 100 UK local authorities was invested in Icelandic banks. Representatives from each council are meeting to try to persuade the Treasury to secure the money in the same way that customers' money in Icesave was fully guaranteed. Of all the local authorities, Kent County Council has the most money invested in Icelandic banks, currently £50 million. Transport for London, the organisation that operates and coordinates transport services within London, also has a large investment at £40 million. Local authorities were working under government advice to invest their money across many national and international banks as a way of spreading risk. Other UK organisations said to have invested heavily include police services and fire authorities, and even the Audit Commission. It is hoped that about one-third of the deposited money will be available fairly rapidly, corresponding to the liquid assets of the UK subsidiaries: liquidation of other assets, such as loans and offices, will take longer.
In an emergency sitting of the Tynwald on 9 October, the Isle of Man government raised compensation from 75 percent of the first £15,000 per depositor to 100 percent of £50,000 per depositor. The Chief Minister of the Isle of Man, Tony Brown, confirmed that Kaupthing had guaranteed the operations and liabilities of its Manx subsidiary in September 2007, and that the Manx government was pressing Iceland to honour this guarantee. Depositors with Landsbanki on Guernsey found themselves without any depositor protection.
On 11 October, an agreement was reached between the Icelandic and Dutch governments on the savings of about 120,000 Dutch citizens. The Icelandic government will cover the first €20,887 on savings accounts of Dutch citizens held by Landsbanki subsidiary Icesave, using money lent by the Dutch government. The total value of Icesave deposits in the Netherlands is €1.7 billion. At the same time Iceland and Britain reached an agreement on the general contours of a solution: Icesave deposits in the UK total £4 billion (€5 billion) in 300,000 accounts. The figure of €20,887 is the amount covered by the Icelandic Depositors' and Investors' Guarantee Fund however, the DIGF had equity of only 8.3 billion krónur at the end of 2007, €90 million at the exchange rates of the time and far from sufficient to cover the Dutch and British claims.
| This article uses material from the Wikipedia article "2008 Icelandic Financial Crisis" |
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