Question

Causes, costs, resolution methods and regulatory lessons of Icelandic Banking Crises

Answer 1

Icelandic financial crisis began in earnest in mid Sept. 2008. The combined assets of the three largest Icelandic Banks amounted to ten time the country's total Gross Demestic Product (GDP) at the time of their collapse. Two-thirds of the banks liabilities were denominated in a foreign currency. When the world's credit market died up, the banks were unable to refinance their loans and the government as a lender of the last resort, was unable to offer backing to the privately owned banks.

.In October 2008, Iceland nationalizeed its three largest banks - Kaupthing Bank, Landsbanki and Glitnir Bank had defaulted on USD 62 Billion of foreign debt. Thebank's collapse sent foreign investors out of Iceland. That sent the krona down 50 percent in one week. The stock market fell 95% . Almost every buysiness in Iceland went bankrupt. Housing prices fell, while mortgage costs doubled. Due to the size of the combined balance sheet of those banks the government of Iceland did not have the means to save those banks. They were put into receivership instead with their boards replaced.

Iceland's almost bankrupt economy caused the governjment to collapse in January 2009. The failure occurred because Prime Minister Haarde resigned due to cancer.

Iceland's economic collapse affected the rest of Europe. That is because Iceland's banks had expended their retail services in Europe. They had also invested in foreign companies. Iceland's Baugur was the largesst privatge company in Great Britain. IceSave, the online arm of Landsbanki, froze withdrawals during the crisis. That effected depositors throughout Europe.

Since the Government was unable to maintain the value of the Krona, many suggested Iceland join the European Union and adopt the Euro as its currency. Iceland is already a member of the European Economic Area, a trade association that follows many EU rules. But Island's fishing industry is opposed. It clashed with European countries over fishing rights.

In February 2009, voters elected Johanna Sigurdardottir and her coalition. She barred capital from leaving the country. She raised taxes. But she also kept social services and provided debt relief to mortgage holders. She prohibited citizens from buying foreign currency or foreign stocks.

As a result people invested in local businesses including real estate and private equity. Tourism boomed when local prices fell thanks to the low currency exchange rate. It increased further after both the 2010 and 2011 volcanic eruptions.