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1. The Icelandic Financial Crisis(2008):
Among the first domino falls by the
Lehman Brother failure
Avilasha Chalki - 22060222081
Apoorva Jha - 22060222057
Bhavya Pandey - 22060222083
Agney Shaji - 22060222022
Aman Burman - 22060222031
Aruwa Ansari- 22060222070

2. ABSTRACT
This report examines Iceland's 2008–2009
banking crisis, which in some ways was
unprecedented. The three banks, Kaupthing,
Landsbanki, and Glitnir, made up almost 80% of
the financial sector and had witnessed break-
neck development, making the crisis' scale and
pace unmatched elsewhere. Through this paper,
the factors that led to the Icelandic financial
crisis, its economic impact, and Iceland’s
eventual recovery from the crisis is discussed
thoroughly. It discusses the economic and social
reaction to the unparalleled crisis, which was
essentially a result of a consequential chain
reaction after the failure of the Lehman Brothers.
Further, the report analyzes and highlights the
methods of bank restructuring, resolution to the
crisis and the lessons learnt following the crisis,
by every other economy, around the world.
Introduction : Rise of the Icelandic
Banks

3. Iceland, a tiny island nation in the middle of the Atlantic Ocean, experienced one of the worst
financial crises in modern history in 2008. Within the span of a week, the whole banking system
of the nation fell apart, sparking widespread unrest that ultimately led to the resignation of the
government. By the middle of the 1990s, financial market reforms had greatly liberalized capital
flows into and out of the nation, making Iceland's markets and banks popular with foreign
investors. Over 95% of the country's financial sector was made up of the three largest banks in
the nation, Kaupthing, Landsbanki, and Glitnir, which together held assets worth 10 times the
GDP of the nation.
A little bit the past of Iceland’s economic stability:
Iceland has already experienced large and devastating macroeconomic crises.When oil shocks hit
the world economy, the Icelandic economy was badly hurt. In the 1980s, inflation was rampant
and persistent.
x axis: years
y axis: Inflation, consumer prices
(annual %)
Iceland followed a false prosperity based on government interference and participation in
economic activities until the 1980s. Iceland started adopting economic changes towards the end
of the 1980s. At the end of 1980s, Iceland began implementing economic reforms. Throughout
the 1990s, the government trimmed personal and corporate tax rates, privatized state-owned

4. companies, liberalized product and labor markets, deregulated the financial sector and reformed
the pension system.
By the middle of the 1990s, financial market reforms had liberalized capital flows to and from
other nations, making Iceland's banks and markets popular with foreign investors. But because of
the surge in foreign investment in the late 1990s and early 2000s, Iceland's economy was
particularly exposed to the ups and downs of the world credit markets.
After the economy experienced a mild recession in 2002, the central bank of Iceland repeatedly
raised interest rates as the inflation rate repeatedly exceeded its target limits.
Investors were quite uncertain about the krona which had been one of the most unstable currencies
in the world. As capital inflows came in, the krona appreciated remarkably.
Excessive growth of the banking sector:
The Icelandic banking industry experienced a sharp expansion in the years prior to the crisis. Early
in the 1990s, Iceland's banking sector started to deregulate; after ratifying the European Economic
Area (EEA) agreement in 1994, Iceland joined the European Single Market. The EEA membership
and its "one passport" policy helped the banks expand into other European countries.

5. After Landsbanki and Bunadarbanki were privatized, the latter bank's merger with Kaupthing in
2003 saw a dramatic increase in asset growth. The acquisition of foreign businesses was also
important. The aggregate assets of the three largest Icelandic banks, Kaupthing, Glitnir, and
Landsbanki, more than doubled during the global liquidity booms of 2004 and 2005. The banking
sector's growth much outpaced that of the entire economy, and neither Icelandic regulation nor
oversight were able to stop it.
Prior to the turn of the century, the country's banks relied on domestic deposits and long-term loan
deposits from foreign financial institutions for funding. However, The banks were able to gather
deposits in Europe and engage in collateralized borrowing from the European Central Bank, as the
European financial market became increasingly linked. The Icelandic banks benefited from the
substantial levels of global liquidity that were present at the time; they went from being a low-
rated investment to a high-rated one, which increased capital inflows into the nation and caused a
boom in the banking industry.
During the early 2000s, when the economy saw this exponential expansion, the nation's central
banks raised interest rates, making borrowing more expensive for firms and households.Foreign
investors were now drawn to investing in krona-related assets as the value of the Icelandic currency
increased. They would borrow money at cheaper interest rates in other currencies and make
investments in krona-denominated assets. The carry trade proved quite profitable as the krona
continued to appreciate and the differential remained favorable. The growth of the banks surpassed
that of the economy by a wide margin, and Icelandic legislation and oversight could not keep up
with it.
Development and Causes:

6. The events leading up to Iceland's financial crisis are outlined in this section. It highlights the flaws
in the three largest banks and what made them vulnerable to the Great Financial Crisis of 2007–
2009, which overtook Iceland following the failure of Lehman Brothers in September 2008.
Currency:
From January to September 2008, the Icelandic króna had lost more than 35% of its value versus
the euro. Iceland's interest rates had been hiked to 15.5% in order to address the high inflation,
which was running at 14%.The Central Bank of Iceland abandoned its attempt to peg the Icelandic
króna to the euro during the night of Wednesday, October 8, 2008, after attempting to do so on
October 6. By the time the FME took control of the final big Icelandic bank on October 9 and
eliminated all króna trade "clearing houses," the Icelandic króna was trading at 340 to the euro. As
a result, trading in the currency plummeted.
The decline of the Icelandic króna against the euro,
shown from September to November 2008. The
lower solid line (in brown) shows the offshore rate
as quoted by the European Central Bank; the higher
solid line (in blue) shows the onshore rate as quoted
by the Central Bank of Iceland.
On the one hand, there was a tendency for the exchange rate of the króna and the share prices of
the banks to rise simultaneously due to a lack of risk aversion and an availability of liquidity.
However, because the banks were listed in Iceland and had krónur-denominated equity, taking a
speculative position against their share prices contributed to devalue the króna. Additionally,
because the banks' official accounts and equity were denominated in Icelandic krónur even though
2/3 of their balance sheet was actually denominated in foreign currency, they tended to hedge their
equity, which caused the króna to continue to lose value during the time when it was already losing
value.

8. The provided graphs demonstrate the strong correlation between international liquidity conditions as determined by
an index created by the Bank of England, the exchange rate of the Icelandic króna, and the share prices of publicly
listed financial institutions.
Sovereign debt:
Prior to the turn of the century, Icelandic banks
were mostly funded by local deposits and long-
term loans from international financial
institutions. This changed, however, as the
European financial sector grew increasingly
interconnected. Although Iceland is not a member
of the European Union, it is a member of the
European Economic Area, providing it basically
the same access to financial markets as EU
member nations. This included permitting
Icelandic banks to operate subsidiaries and branches in EU member nations, allowing the banks to
collect deposits in Europe and engage in collateralized borrowing from the European Central Bank
(ECB). Both would prove to be significant financial sources once the international liquidity crisis
began in the middle of 2007.
To fuel their fast development, the top three banks increasingly depended on foreign capital,
resulting in a scenario of high government debt accounting for about 28% of GDP. Iceland's
citizens were concerned that the country had borrowed six times more than it generated in a year.
The agencies expected the government to issue additional foreign currency bonds, both to offset
losses when the banks' overseas businesses were liquidated and to boost local demand as Iceland
entered a recession.
At the beginning of October 2008, an International Monetary Fund (IMF) team came in Iceland
for negotiations with the government to stabilize the króna and allow interest rates to be decreased.
The IMF provided $2.1 billion on November 19, along with $2.5 billion in loans and currency
swaps from Norway, Sweden, Finland, and Denmark.
The country's three major banks went bankrupt after amassing massive sums of short-term debt;
they were expanding at a breakneck pace, accruing more and more debt and selling it to other
European countries.

9. Liquidity and funding worries:
There were three stages to bank
financing. The big three banks
increasingly relied on foreign funding
to sustain their explosive growth. They
have three different sorts of funding
that they have utilized consecutively
over time. These included medium-
term notes (MTN), foreign deposits,
and collateralized borrowing from
central banks.
Icelandic banks issued debt in the
European MTN market during the
initial phase before switching to the
US MTN market as demand for their bonds in Europe decreased. Around the time of the Geyser
crisis, it became increasingly challenging for Icelandic banks to access the euro MTN market. As
a result, they began to progressively use the US MTN market as a substitute. Icelandic banks issued
a total of 45 billion euros between 2004 and 2008, which made up a sizable portion of their
aggregate balance sheet in that year.
After the Geyser crisis, deposit collection overseas began in earnest. Beginning with the euro MTN
markets, the impact on market confidence impacted Icelandic banks' access to wholesale finance.
In response, all three of Iceland's main banks increased their marketing campaigns to draw deposits
from overseas and online. To entice deposits, all three banks provided relatively high-interest rates.
Foreign deposits reached EUR 16 billion by the middle of 2008, accounting for 15% of the
combined balance sheets of Landsbanki and Kaupthing.
Icelandic banks turned to central banks for funding as their ability to collect foreign deposits began
to decline in the middle of 2007. At its peak in 2007, collateralized borrowing from central banks,
particularly the CBI and the ECB, increased to EUR 9 billion by year's end, up from EUR 2 billion
about a year earlier. Through their subsidiaries in Luxembourg and the Central Bank of
Luxembourg, Icelandic banks' borrowing from the ECB significantly increased.
The caliber of the bank-provided collateral was a serious issue with this increase in central bank
borrowing. Icelandic banks issued bonds and traded them among themselves so they could be used
as collateral with the central banks. By being able to issue such bonds at will, they were able to
bypass funding restrictions imposed by the central bank. Due to rising funding constraints, these

10. practices started to spread throughout Icelandic banks, and the ECB refused to accept any further
Icelandic bank bonds as security. The CBI nevertheless kept taking these bonds because they were
worried about systemic stress. It was probably concerned at that point that its reluctance to accept
them as collateral would worsen the Icelandic banks' funding issues and raise the possibility that
they would fail.
The failure of Lehman Brothers:
Lehman Brothers was a multinational financial services
corporation. It offered investment banking, trading, asset
management, private banking, research, brokerage,
private equity, and other related services. Until
September 15, 2008, the company was one of the largest
investment banks in the United States. The subprime
mortgage crisis primarily caused and expedited its
demise. Its bankruptcy is still the biggest in history.
The Lehman Brothers collapse triggered a second crisis
in the United States, and financial markets worldwide
became unstable, resulting in a global crisis. The world's economy were collapsing one by one like
dominoes, including Iceland's. The repercussions were disastrous for Iceland, a country that was
at the top of its economy and quality of life; following the banking sector crisis, the government
did not have enough finances to assist, and the value of their loans was too high.
Because of internal imbalances, Iceland was particularly vulnerable to the global financial crisis.
The bank's assets and liabilities were heavily denominated in foreign currencies, and the financial
industry as a whole was out of proportion. Furthermore, despite the fact that the largest banks were
linked by credit, there was no reliable lender of last resort for foreign money. The endeavor to
increase foreign reserves in order to give foreign currency liquidity to banks proved unsuccessful.
By the middle of 2008, the banks' sources of funding had run dry. Consumer trust in Icelandic
banks deteriorated when wholesale financing could no longer be renewed, customer deposits were
withheld, or central bank collateralized lending had reached its maximum limit.
Separately, after Lehman Brothers collapsed in mid-September 2008, repo and money markets
dried up, escalating funding stress in the global financial markets that had begun in 2007.
Glitnir Bank asked the CBI for Emergency Liquidity Assistance (ELA) on September 25. When
Glitnir attempted to make payments on four different facilities totalling EUR 600 million, it ran

11. out of market choices because it had been having trouble finding capital in foreign currencies for
some time. These had a mid-October deadline. Four months later, more, sizable installments were
due. CBI rejected the request and proposed a partial nationalization in its place, with the
government willing to pay EUR 600 million to acquire 75% of the bank.
Following the announcement of Glitnir's nationalization, its funding issues worsened and spread
to other banks. Following the news, credit default swap spreads increased sharply, and the same
day, Standard & Poor's downgraded both Glitnir and the sovereign by three notches. Other rating
services did the same. As a result of the declining value of the collateral pledged in repo
agreements, EUR 425 million of Glitnir's funds was called in addition to EUR 1,100 million in
margin calls. Retail depositors began withdrawing their funds, which added to the funding issues
the three banks were already having. Eventually, there was a widespread and growing run on all
of Iceland's banks, putting them in danger of failure.
Domestic Impact of Icelandic
Financial Crisis:
At the end of 2008, Iceland had experienced one of the most severe financial crises in the world
since the end of World War II. Plummeting krona currency value became inevitable following the
financial crisis during the late 2008 and early 2009. Therefore, the domestic impact of crisis clearly
extended from the business sector to the individual households. The fiscal cost of the financial
crisis was estimated at 65 percent of the GDP in euro terms, foreign obligations have risen to over
100 percent of GDP and the economy is expected to decline by 15 percent in krona terms. The
banking system collapsed and the economy slipped into the deepest recession ever recorded in
small and open economies in the last 20 years. The unemployment rate, which had been
remarkably low in the recent decade, is expected to surpass 10 percent in the next two years. One
economist later estimated that the nation was €20 to €30 billion in debt. On the household level,
the average Icelander was $403,000 in debt and 25% of homeowners faced mortgage default.
The main concerns for the instability of Iceland's financial sector were extensive foreign currency
funding, overdraft spreads of credit default swaps, high interest rate parity between Iceland and
the rest of the world along with an increasing stock of debt which emerged from increased

12. financing of mortgages. Massive foreign debt, created mostly by the financial sector, was 9 times
the size of Iceland’s GDP. The immense size of the foreign debt was an unfortunate consequence
of the fact that Icelandic banks had not insured the borrowing and credit activity with depository
basis. Prices on the stock market undertook a major fall as did the value of collateral. Icelandic
firms faced margin calls from their foreign lenders. They were required to provide more collateral,
in the form of securities issued by the banks, which they successfully obtained. After the banking
sector exhibited symptoms of insolvency and liquidity problems and as the krona depreciated
further, major commercial banks were unable to obtain short-term funding.
The international impression of the Icelandic banking sector worsened due to its engagement in
the money markets, high exposure risk and the negative global financial outlook. Interest rate
parity decreased. Foreign deposits evaporated. Between February 10 and April 22 in 2008, one
billion pounds were withdrawn from Landsbanki. Foreign investors withdrew their investments
and refused to continue credit default swap agreements. As a consequence of currency
depreciation, inflation soared. In January 2009, the inflation rate was 18.6 percent. In the following
months, it shrank to 17.6 percent and 15.2 percent respectively. The UK government froze
Landsbanki’s assets using the Anti-terrorism, Crime, and Security Act when the Icelandic
government refused to honour its debts to foreign investors. This meant that 400,000 British and
Dutch savers could lose their money. The UK and Dutch governments had to compensate these
savers using taxpayer money.
Below is the table which shows the inflationary dynamics in the OECD countries between 1980
and 2009:

13. In the late 20th century, Iceland experienced the most volatile inflation rates among advanced countries. In other
words, the highest standard deviation of inflation rate from 1980 to 2009. During that period, Iceland had the
highest average inflation rate of all advanced OECD countries.
Stock Markets
Trading in the shares of six financial companies on the OMX Nordic Iceland stock exchange
was suspended on October 6 following FME's order. On Thursday, October 9, the government
froze all stock market transactions for two days "to prevent a further spread of panic in the
country's financial markets." The decision to do so was due to "unusual market conditions",
with the share price down 30% since the start of the month. Due to “unusual

14. market conditions”, the closure has been extended until Monday, October 13.
The market reopened on October 14, with the main OMX Iceland 15 index trading at 678.4,
down about 77% from 3,004.6 before the close. This reflects the fact that the value of the
three largest banks, which account for 73.2% of the value of OMX Iceland 15, has been set to
zero. The value of the other stocks varied from +8% to -15%. The shares of Exista, SPRON
and Straumur- Burðarás (13.66% of OMX Iceland 15) remained suspended After a very thin
week of trading, the OMX Iceland 15 closed at 643.1 on October 17, up 93% in koruna and
96% in euros from it's all-time high of 9016 (July 18, 2007) .
Shares of two financial services companies Straumur–Burðarás and Exista resumed trading
on December 9: the two companies together account for 12.04% of OMX Iceland 15 Shares
of both companies fell sharply in value, the index closing at 394.88, down 40.17% for the
day Shares of SPRON and Kaupthing remain suspended at SEK 1.90 and SEK 694.00
respectively.
Bank Restructuring
In 2001, the Icelandic government deregulated the banking sector. This move allowed banks to
operate without many of the restrictions that had been in place previously. As a result, the
banking industry in Iceland flourished.This created a situation where banks could upload debts
when foreign companies were accumulated.The crisis began when banks could not repay their
loans.The three major banks in Iceland are estimated to have held foreign debt in excess of €50

15. billion, which is about €160,000 per Icelandic resident. This is compared to 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 significantly higher than for other banks . Banks in Europe typically
charge interest rates for deposits more than banks in other parts of the world. However, there are
some exceptions. For example, banks in Switzerland often charge higher interest rate deposits
(1⁄2% of the sum deposited) than banks in other European countries.The króna has been
struggling due to the effects of carry trading. This has caused it to be ranked by The Economist
as the most overvalued currency in the world. Iceland's banks have traditionally financed their
expansion by borrowing from other banks in the interbank lending market. More recently, they
have also started to raise funds by accepting deposits from investors outside Iceland. This is
another form of external debt.Households in the United States took on a large amount of debt in
the years leading up to the financial crisis of 2008. This debt was equivalent to 213% of
disposable income, which led to inflation.
The inflation rate in Iceland was exacerbated by the Central Bank's practice of issuing liquidity
loans to banks based on newly issued, uncovered bonds. In other words, the Central Bank was
effectively printing money on demand. In response to the sharp increase in prices – 14% in the
twelve months to September 2008, compared with a target of 2.5% – the Central Bank of Iceland
raised interest rates to 15.5%.The high interest rates in Iceland, compared to other countries,
encouraged investors to put their money into Icelandic banks. This led to an increase in the
money supply and inflation.The króna was in an economic bubble, with investors overestimating
its true value. The Icelandic banks were having difficulty rolling over their loans in the interbank
market. Their creditors were insisting on payment, but no other banks were willing to make fresh
loans.In a situation like this, a bank would usually have to take out a loan from the central bank
as the lender of last resort.In Iceland, the banks were so large in comparison to the national
economy that the Central Bank of Iceland and the Icelandic government could not guarantee the
payment of the banks' debts, resulting in 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. This is
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.
Crisis Resolution
A washing post article wrote, “Iceland's recovery has become a myth wrapped in a legend inside
a legend. It let its banks fail, slashed household debt, let its currency collapse, put capital controls
in place—and now it's doing better than those countries that did austerity!” Iceland was among
the first countries to be affected by the global financial crisis .Relying mostly on foreign
borrowings and having accumulated assets worth up to 10 times the country’s GDP, the banking

16. system there was relatively large as compared to the economy and the three biggest banks
namely Glitnir, Landsbanki, and Kaupthing collapsed, triggering the crisis. The conditions
worsened, and the currency saw a steep depreciation in the early 2008. Due to decline in
confidence, foreign deposits and other short term funding in foreign currencies were withdrawn.
Many were thus astounded when the economy underwent such a fast recovery and returned to
growth in 2011. Iceland’s recovery was thus, very much significant.
● ELA (Emergency Liquidity assistance) was one of the first-response mechanisms to be
taken into consideration as the pressure on Icelandic banks intensified. The Central Bank
Act in effect at the time stated that the CBI could grant ELA in exceptional situations
where the standard restrictions governing rates and collateral need not apply ,in order to
maintain trust in the financial system.
● Glitnir and Kaupthing, two banks, submitted ELA applications. Both requests were for
loans in the form of euros, which made up a sizable portion of the CBI's foreign reserves.
ELA was used as the first line of defense because it was thought that the banks were only
illiquid, not insolvent.Glitnir’s loan was rejected while kaupthing’s loan was granted,
however this also did not prevent the bank from defaulting.In terms of Euros, kaupthing
received an ELA that was equivalent of 5% of the nation’s total foreign exchange
reserves.Clearly this wasn’t even close to being enough for the banks to withstand a time
of extremely low market confidence. ELA therefore didn’t do much and turned out to be
ineffective as a policy response.
● ACT 12/2008, also known as the “Emergency act” , was approved by the Icelandic
parliament on October 6th
which gave the Financial Supervisory Authority (FME) the
power to take over the financial undertakings that were having unusually severe operational
or financial circumstances. Domestic and international deposits were also classified as
priority claims according to the act. It was done as follows:
● Earlier , the authority to intervene in the matters of failing banks were very restrictive in
nature, that is while the FME had the right to suspend the bank’s license and begin the
liquidation process, it would not have been able to carry out a swift resolution that
preserved crucial financial and banking services.

17. ● Early in 2006, the Icelandic government began to acknowledge the need for FME to
have resolution powers, and in spring 2008, the ministry of business affairs began
drafting the emergency act using the FME’s prior work and the scenarios as discussed in
the consultative group.
● Three significant modifications were made by the emergency act, starting with the
authority granted to the ministry of finance to fund the creation of new financial
institutions or restructuring of those who were failing or were likely to fail (FOLF),
along with the new powers to intervene in the functioning of failing banks. These
interventions included the right to hold a shareholder’s meeting and make necessary
choices if the situation called for it.The board could be given fewer powers, be
completely or partially dismissed, and have control over the transfer of it’s assets and
liabilities.
● All three banks were divided into “new” and “old” banks. This can be broken down into
four steps. The initial phase was moving a few assets and liabilities to a brand new
bank.The second was the valuation of the assets that were transferred to the new banks.
The new banks were then funded and capitalized.The ancient banks were eventually shut
down. The new banks formed were Islandsbanki, Arion bank and landsbankinn.
In order to generate market confidence, the government announced that all deposits were
guaranteed in full, however this did not include deposits in foreign branches that were made in
foreign currencies because such a claim would not have been credible given Iceland’s balance of
payment crisis.
Economic Stabilization Programme and the role of IMF
The three major targets to be achieved were
1. Stabilization of exchange rate
2. Fiscal sustainability
3. Reconstruction of financial sector

18. To stop excessive capital withdrawals and stabilize the krona, the government implemented
capital controls as a part of the IMF programme in November 2008.The twin currency and
systemic banking crisis, as well as the inevitable unraveling of Iceland’s macroeconomic
imbalances, had significant economic repercussions: output shrank by 10% between 2008-10,
consumption fell by 23% and unemployment increased from 2.3% to 7.6%. The $2.1 billion
IMF-backed programme is still one of the biggest in terms of the size of the economy; it
represents 18% of Iceland's GDP or 1,190% of its IMF quota.As a result of the regulations, the
exchange rate was stabilized and inflation decreased. By protecting the economy against shocks
to the global financial system, the regulations also aided in the recovery from the crisis. The
Icelandic crisis had a significant direct financial cost, but the program's significant and painful
budgetary tightening was necessary to prevent a sovereign debt catastrophe. This assisted in
recovering the trust of global markets. The IMF programme was designed and implemented
incorrectly, but overall we believe it made a positive contribution. During the height of the crisis
in 2009–2010, when it was most necessary to rebuild trust both locally and abroad, the
programme offered one of the components.
Lessons from the Icelandic Banking
Crisis
There are several lessons that can be learned from how the Icelandic crisis was handled. This
section offers some overarching lessons that can be learned from the crisis. These lessons are as
follows:

19. 1. Transparent firm ownership is needed to facilitate supervision of insider lending and
large exposures.
Firm ownership is still not transparent in Iceland despite the well documented abuses of rules
and regulations which took place in the shadow of opaque ownership. The large banks in Iceland
overfunded their own shares, significantly decreasing their equity's ability to absorb shocks and
so raising systemic risk. By the middle of 2008, each bank was funding, on average, 25% of its
own shares; this equates to 33% of the shares in the three major banks when cross-funding of
shares is considered. This came to almost 4 billion euros. When the banks failed, these loans lost
all their value, leaving depositors and other creditors in the same situation as if the equity had
never existed as a safety net. Thus, in the middle of 2008, the capital adequacy ratio for the
banks was overestimated. Instead of the 11 percent, the loss-absorbing capital buffer was only
roughly 8 percent.
2. Strict regulations are needed against lending the bank’s own shares also against
lending with collateral in other financial institutions shares
Large portions of the loans with significant losses were made in the final months before the bank
failure. The risk to the Icelandic economy was increased by some of these, which involved the
repatriation of debts from abroad. Numerous recipients of these loans were substantial debtors,
frequently insiders who were facing financial difficulties. The cost of the bank's failure grew as a
result of this "gamble for resurrection."
3.. Cross-border deposits and liabilities have substantially weaker implicit government
assurances.

20. The CBI served as the banks' lender of last resort as their borrowing and lending activities were
increasingly conducted in foreign currencies. Once the crisis began, the banks swiftly lost their
ability to borrow money in foreign currencies, and regardless of whether they were solvent or
not, they were destined to fail without a lender of last resort. Swap lines with the appropriate
Central banks could prevent a run, but they are typically not guaranteed in a credible way before
a crisis, thus they should not be relied upon. The CBI served as the banks' lender of last resort as
their borrowing and lending activities were increasingly conducted in foreign currencies. Once
the crisis began, the banks swiftly lost their ability to borrow money in foreign currencies, and
regardless of whether they were solvent or not, they were destined to fail without a lender of last
resort. Swap lines with the appropriate Central banks could prevent a run, but they are typically
not guaranteed in a credible way before a crisis, thus they should not be relied upon.
4. Banks might experience self-fulfilling runs once they are permitted to conduct
business internationally or in other currencies simply because they lack access to a
lender of last resort that accepts the currency in which they operate.
In the years prior to the crisis, capital inflows expanded swiftly. International borrowing shot up
exponentially, driven by Icelandic banks, which distributed the money to businesses and
households. The likelihood of a full-blown financial collapse rose as a result of this capital
inflow bonanza. When the crisis began, the abrupt halt put local businesses, people, and
governments at risk of insolvency. The Icelandic story is a clear illustration of how capital
inflows can aggravate economic swings and how impending capital flight therefore makes policy
extremely difficult.
5. It is wise to have a crisis resolution strategy in place in advance. When establishing
"new banks," it is vital to take additional factors into account in addition to capital
adequacy, such as term mismatch, liquidity, asset encumbrance, and currency
mismatch.
The write-downs made as the new domestic banks were established were obviously significant
because they gave room to clean up the balance books of households and businesses without
impacting the capital of the new banks and, in some cases, to avoid the expensive bankruptcy
process. In addition, government policy—including the pension fund system and direct

21. government funding of homeowners' home equity—proved crucial in reducing household debt.
This boosted spending, which in turn aided the economy's recovery.
Corporate Debt Household Debt
Conclusion
Beginning with the rise of the Icelandic Banks, led by the liberalization and privatization of the
banking sector in 2003, the report analyzed the growth of the three major banks of Iceland, namely,
Kaupthing, Landsbanki, and Glitnir which together overpowered the national GDP by ten times.
Clearly creating a bubble, it led to one of the worst financial crises in history of Iceland or for that
matter, the world. A brief overview of Iceland’s economic history explains the economic
prosperity preceding the crisis.

22. Furthermore, the development and causes link the history with the crisis and the economic build
ups which led to the financial crisis. And while the excessive growth of the banking sector
eventually pushed the entire national economy down a cliff, its impacts over the domestic economy
of Iceland has been discussed including the stock market, krona currency value, the private and
public sector businesses and the bank restructuring.
Finally, the crisis resolution covered the major policy changes that were undertaken by the
government, supported by the financial sector, to overcome the crisis and strengthen the economy.
As any major event in history, this economic event too has provided us with lessons for other
economies, like transparent firm ownership, stricter regulation against some of the banking
practices, identifying a lack of a lender of last resort for banks in any nation when conducting
business internationally, etc. These points have also been included towards the end of the report.
Bibliography
Domestic Impact of the Financial Crisis:
● https://core.ac.uk/download/pdf/213926277.pdf
● https://www.reuters.com/article/us-iceland-meltdown-events-idUSTRE60420G20100105
● https://sevenpillarsinstitute.org/case-study-icelands-banking-crisis/
● https://www.brookings.edu/wp-content/uploads/2018/02/benediktsdottirtextfa17bpea.pdf
Lessons from the Icelandic Banking Crisis

23. ● https://centerforfinancialstability.org/iceland/benediktsdottir_paper.pdf
● https://www.policyforum.net/10-year-recovery-lessons-iceland/
● https://www.bis.org/fsi/fsicms1.pdf
Causes and Development
● https://wits.worldbank.org
● https://data.worldbank.org/indicator/NY.GDP.DEFL.KD.ZG?end=1994&locations=IS&s
tart=1961
● https://journals.sagepub.com/doi/pdf/10.1080/14034940310019489
● https://www.brookings.edu/wp-content/uploads/2018/02/benediktsdottirtextfa17bpea.pdf
Stock Market
● https://journals.sagepub.com/doi/pdf/10.1080/14034940310019489
● https://www.brookings.edu/wp-content/uploads/2018/02/benediktsdottirtextfa17bpea.pdf
Bank Restructuring
● https://sevenpillarsinstitute.org/case-study-icelands-banking-crisis/
● https://www.brookings.edu/wp-content/uploads/2018/02/benediktsdottirtextfa17bpea.pdf
Crisis Resolution
● https://www.emerald.com/insight/content/doi/10.1108/978-1-78743-347-
220181008/full/html
● https://cepr.org/voxeu/columns/was-imf-programme-iceland-successful
● https://www.imf.org/en/News/Articles/2018/09/15/sp091518-ragnarok-iceland-s-crisis-
its-successful-stabilization-program-and-the-role-of-the-imf