2008–2011 Icelandic financial crisis
The Icelandic financial crisis was a major economic and political event in Iceland between 2008 and 2010. It involved the default of all three of the country's major privately owned commercial banks in late 2008, following problems in refinancing their short-term debt and a run on deposits in the Netherlands and the United Kingdom. Relative to the size of its economy, Iceland's systemic banking collapse was the largest of any country in economic history. The crisis led to a severe recession and the 2009 Icelandic financial crisis protests.
In the years preceding the crisis, three Icelandic banks, Kaupthing, Landsbanki and Glitnir, multiplied in size. This expansion was driven by ready access to credit in international financial markets, in particular money markets. As the 2008 financial crisis unfolded, investors perceived the Icelandic banks to be increasingly risky. Trust in the banks gradually faded, leading to a sharp depreciation of the Icelandic króna in 2008 and increased difficulties for the banks in rolling over their short-term debt. At the end of the second quarter of 2008, Iceland's external debt was 9.553 trillion Icelandic krónur, more than 7 times the GDP of Iceland in 2007. The assets of the three banks totaled 14.437 trillion krónur at the end of the second quarter 2008, equal to more than 11 times the national GDP. Due to the huge size of the Icelandic financial system in comparison with the Icelandic economy, the Central Bank of Iceland was unable to act as a lender of last resort during the crisis, further aggravating the mistrust in the banking system.
On 29 September 2008, it was announced that Glitnir would be nationalised. However, subsequent efforts to restore faith in the banking system failed. On 6 October, the Icelandic legislature instituted an emergency law which enabled the Financial Supervisory Authority to take control over financial institutions and made domestic deposits in the banks priority claims. In the following days, new banks were founded to take over the domestic operations of Kaupthing, Landsbanki and Glitnir. The old banks were put into receivership and liquidation, resulting in losses for their shareholders and foreign creditors. Outside Iceland, more than half a million depositors lost access to their accounts in foreign branches of Icelandic banks. This led to the 2008–2013 Icesave dispute, which ended with an EFTA Court ruling that Iceland was not obliged to repay Dutch and British depositors minimum deposit guarantees.
In an effort to stabilize the situation, the Icelandic government stated that all domestic deposits in Icelandic banks would be guaranteed, imposed strict capital controls to stabilize the value of the Icelandic króna, and secured a US$5.1bn sovereign debt package from the IMF and the Nordic countries in order to finance a budget deficit and the restoration of the banking system. The international bailout support programme led by IMF officially ended on 31 August 2011, while the capital controls which were imposed in November 2008 were lifted on 14 March 2017.
The financial crisis had a serious negative impact on the Icelandic economy. The national currency fell sharply in value, foreign currency transactions were virtually suspended for weeks, and the market capitalisation of the Icelandic stock exchange fell by more than 90%. Iceland underwent a severe economic depression. Its gross domestic product dropped by 10% in real terms between the third quarter of 2007 and the third quarter of 2010. A new era with positive GDP growth started in 2011, and has helped foster a gradually declining trend for the unemployment rate. The government budget deficit has declined from 9.7% of GDP in 2009 and 2010 to 0.2% of GDP in 2014; the central government gross debt-to-GDP ratio was expected to decline to less than 60% in 2018 from a maximum of 85% in 2011.
Development
Currency
The Icelandic króna declined more than 35% against the euro from January to September 2008. Inflation of consumer prices was running at 14%, and Iceland's interest rates had been raised to 15.5% to deal with the high inflation.On the night of Wednesday, 8 October 2008, 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 within Iceland. From 9 October to 5 November, the European Central Bank quoted a reference rate of 305 krónur to the euro.
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%. The foreign exchange reserves of the Central Bank of Iceland fell by US$289 million during October 2008.
During November, the real exchange rate of the Icelandic króna, as quoted by the Central Bank of Iceland, was roughly one-third lower than the average rate from 1980 to 2008, and 20% lower than the historical lows during the same period. The external rate as quoted by the European Central Bank was lower still. On the last trading day of the month, 28 November, the Central Bank of Iceland was quoting 182.5 krónur to the euro, while the European Central Bank was quoting 280 krónur to the euro.
On 28 November, the Central Bank of Iceland and the Minister for Business Affairs agreed on a new set of currency regulations, replacing the central bank's restrictions imposed early on in the crisis. Movements of capital to and from Iceland were banned without a license from the central bank. It was estimated at this time that foreign investors held some €2.9 billion in króna-denominated securities, popularly known as "glacier bonds".
The foreign exchange rules also oblige Icelandic residents to deposit any new foreign currency they receive with an Icelandic bank. There is anecdotal evidence that some Icelandic exporters had been operating an informal offshore foreign exchange market, trading pounds and euros for krónur outside the control of any regulator and starving the onshore market of foreign currency. Hence the Central Bank had to sell €124 million of currency reserves in November 2008 to make up the difference, compared with an estimated trade surplus of €13.9 million.
The last currency auction was held on 3 December. The domestic interbank foreign exchange market reopened the following day with three market makers, all of them government-owned. On the first two days of domestic trading, the króna climbed to 153.3 to the euro, up 22% against the last currency auction rate.
In January 2009, the exchange rate of Icelandic króna against Euro seemed to be more stabilized compared with the situation in October 2008, with the lowest rate at 177.5 krónur per EUR on 1, 3 and 4 January 2009, and the highest at 146.8 on 30 January 2009. In the meantime, however, Iceland's 12-month inflation in January 2009 climbed to a record high of 18.6%.
Banks
In September 2008, internal documents from Kaupthing, the largest bank in Iceland, were leaked to WikiLeaks. 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% 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 FME before the initial plan of the Icelandic government to purchase a 75% 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 Iceland's other banks. Influential BBC business editor Robert Peston published an opinion piece on the banks, stating that debt insurance for Kaupthing 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 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 in a speech that became infamous for its portentous closing words: 'God bless Iceland'. He 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 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 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. The same day, the FME also placed Glitnir into receivership.
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, Davíð Oddsson, was interviewed on Icelandic public service broadcaster RÚV and stated that "we do not intend to pay the debts of the banks that have been a little heedless". He compared the government's measures to the U.S. intervention at Washington Mutual, and suggested that foreign creditors would "unfortunately only get 5–10–15% of their claims".
Darling announced that he was taking steps to freeze the assets of Landsbanki in the UK. The Landsbanki Freezing Order 2008 was passed at 10 am on 8 October 2008 and came into force ten minutes later. Under the order the UK Treasury froze the assets of Landsbanki within the UK, and introduced provisions to prevent the sale or movement of Landsbanki assets within the UK, even if held by the Central Bank of Iceland or the Government of Iceland. 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 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 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 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 available to Kaupthing Bank Sverige AB, the Swedish subsidiary of Kaupthing. The loan was to pay "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 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 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. The Finnish Financial Supervision Authority, Rahoitustarkastus, announced having taken control of Kaupthing's Helsinki branch already on 6th, to prevent money from being sent back to Iceland.
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. One of the banks, Sparisjóðabanki, stated the next day that it could not provide new collateral for its 68 billion krónur 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 a Norwegian export credit company had made a complaint to Norwegian police concerning the alleged embezzlement of 415 million Norwegian kroner 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.