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

1. Iceland’s Financial Meltdown
Sirui Liu
Usman Riaz
Zixuan Yang
Xuan Zhang

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. 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. Factors leading to the Crisis
 Bad banking
 Bad Policies

5. Oversized and vulnerable banking
system
 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. Monetary and exchange rate policy
1. Sharp When bubble
1. Businesses
appreciation 1. Illusion of broke,
households
Raised 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. 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. Expansion of Banking Sectors
 The global economic environment
 The country’s small size
 Financial liberalization and deregulation
 Banks merging
 Global focus

9. Monetary Policy Implementation
 Huge demand for residential housing
 HFF financing
 Borrowing in foreign currency
 Government expansionary fiscal policy

10. Risks Faced By The Banking Sector
 Liquidity Risk
 Credit Risk
 Interest Risk
 Implementation Risk
 Fiscal Risk
 Default Risk

11. Too Big To Fail
VS.
Too Big To Save

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

14.  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

15.  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

16. 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

17. 3 main objectives of IMF
 Preventing further sharp krona depreciation
 Developing a comprehensive and collaborative strategy
for bank restructuring
 Ensuring medium-term fiscal sustainability

18. Recovery and
Challenges Ahead

19. Stabilize: emergency measures to soften the impact
A: mobilize exceptional financing (IMF, Nordics, Poland)
B: impose capital controls
C: allow a large budget deficit (fiscal automatic stabilizer)
D: monetary policy to support exchange rate stabilization
Adjust and unwind: normalization
A: replace exceptional financing with normal finance
B: lift capital controls
C: close the budget deficit over several years
D: new monetary policy framework

20.  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)

22. Challenges ahead
BOP/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 international
climate
Investment/growth/employment:
Resumption of sustained growth
--in the face of household deleveraging
--and fiscal consolidation
--and an unfavorable global climate