Financial crisis in Iceland

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Described the reasons that led to the financial crisis of Iceland. Gave an insight of the banking system and how it contributed to the downfall of the economy. Analyzed the Government's response and the role of IMF in the recovery. Also covered briefly how the recovery was going at that time and what were the challenges that Iceland faced in the near future

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Financial crisis in Iceland

  1. 1. Iceland’s Financial Meltdown Sirui Liu Usman Riaz Zixuan Yang Xuan Zhang
  2. 2. Introduction of Iceland Iceland is  a small European country.  Currency: krona, ISK  Central bank- Central Bank of Iceland(CBI) Industries:  Historically, marine, energy and fishing  Since 1990’s, service production expanded, especially financial services which attribute to 17% GDP in 1998 to 26% GDP in 2006. Rapid growth during 2000 to 2007  Low unemployment  High rates of domestic investment  Government budget surplus and declining government debt
  3. 3. 2008 financial crisis in Iceland Sharp turn in 2007 to 2008  ISK dropped 24% against Euro from Nov 2007 to June2008.  Inflation increased to 11.8% in April 2008.  Home prices began to fall.  The three major banks collapsed.  ISK further depreciated and lost half of value against Euro  Domestic foreign exchange market dried up  Equity market sank.  Current account deficit increased The country fell in to deep recession!
  4. 4. Factors leading to the Crisis Bad banking Bad Policies
  5. 5. Oversized and vulnerable bankingsystem  Rapid expansion over 2000-2006  High liquidity and low interest  Liberalization and deregulation in 1980’s and 1990’s  Highly foreign expansion  Unable to refinance debt  Relied on high leverage to invest (through leveraged buyout)  Credit tightened and krona fell  CBI failed to act as lender of last resort  In 2008, 2 billion Euros-foreign reserve but 50 billion Euros- foreign bank debt
  6. 6. Monetary and exchange rate policy 1. Sharp When bubble 1. Businesses appreciation 1. Illusion of broke, householdsRaised interest 2. High inflow wealth seek foreign Capital outflow rate loans of foreign 2. Current currency and account deficit Currency 2. Carry Trade depreciation capital Price stability over high Floating exchange rate growth and balance on left expose ISK into high current account risk.
  7. 7. Financial System in 2007 Commercial Banks: Glitnir, Kaupthing, and Landsbanki Saving Banks Investment Bank Insurance and Pension Funds Leasing Companies Housing Financing Fund (HFF) Mortgage Credit Institution
  8. 8. Expansion of Banking Sectors The global economic environment The country’s small size Financial liberalization and deregulation Banks merging Global focus
  9. 9. Monetary Policy Implementation Huge demand for residential housing HFF financing Borrowing in foreign currency Government expansionary fiscal policy
  10. 10. Risks Faced By The Banking Sector Liquidity Risk Credit Risk Interest Risk Implementation Risk Fiscal Risk Default Risk
  11. 11. Too Big To Fail VS.Too Big To Save
  12. 12. Government Response Krona dropped 24% Inflation doubled Three major banks collapsed Trade suspended and rise in fiscal deficit and public debt Glitner collapsed CBI was unable to act as the lender as the last resort CBI had 2 Bn Euros compared to 50 Bn of Icelandic foreign bank debt
  13. 13.  Government acquired 75% of Glitner Government Legislation was passed enabling govt. intervention in financial system Govt’s assurance to local deposiotors but not to foreign depositors UK sealed international branches of the three banks Iceland sought International support. Loan was not enough to overcome the huge deficit Iceland’s govt. came to an agreement with UK and EU agreed to support Iceland
  14. 14.  FME took control of three largest banks New resolution committee appointed Landsbanki and Glitner reorganized into new banks New Kaupthing created Krona trading halted CBI kept increasing the policy rate Outflow controlled by capital control No currency change allowed and repatriation of foreign currency
  15. 15. IMF Rescue Iceland requested $2.1Bn from IMF Iceland had to take some steps to get their loan approved New banks with capital adequacy Restructuring Auditing Narrowing the range of collateral accepted by CBI Temporary restriction on capital account transaction
  16. 16. 3 main objectives of IMF Preventing further sharp krona depreciation Developing a comprehensive and collaborative strategy for bank restructuring Ensuring medium-term fiscal sustainability
  17. 17. Recovery andChallenges Ahead
  18. 18. Stabilize: emergency measures to soften the impactA: mobilize exceptional financing (IMF, Nordics, Poland)B: impose capital controlsC: allow a large budget deficit (fiscal automatic stabilizer)D: monetary policy to support exchange rate stabilizationAdjust and unwind: normalizationA: replace exceptional financing with normal financeB: lift capital controlsC: close the budget deficit over several yearsD: new monetary policy framework
  19. 19.  Outlook Projected five-year averages (2011-15) Growth 2-3 percent Trade surplus 7-9 percent of GDP Current account surplus 0-2 percent of GDP Inflation 2.5 percent …and levels by 2015 Unemployment 3-4 percent (8 today) External debt 180 percent of GDP (330 today) Government debt 70 percent of GDP (96 today)
  20. 20. Challenges aheadBOP/exchange rate/capital control:--replace and repay exceptional finance--support the exchange rate--build sufficient reserve cover--while gradually eliminating capital controls--against background of unfavorable internationalclimateInvestment/growth/employment:Resumption of sustained growth--in the face of household deleveraging--and fiscal consolidation--and an unfavorable global climate

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