Iceland and the financial crisis

1、1Iceland and the Financial Crisis- Origins, consequences, lessons -Presentation by the INAO26 February 20102Topics What has happened in Iceland? How the crisis originated and evolved What measures were taken How the INAO was affected Challenges and lessons learned3What has happened? After enjoying a

2、 rapid growth for a number of years Icelands economy took a sharp turn to the worse in 2008 that culminated in October when the Icelandic banking system collapsed. These events correlated with international developments (booming economies followed by a financial crisis). But they had more serious co

3、nsequences in Iceland due to its (relatively) huge banking sector (10 x GDP), its reliance on foreign trade (40% of GDP), foreign currency denominated debts, and other factors.4 Economic and fiscal consequences GDP decreased in real terms by 6% between 2008 and 2009. Predictions for 3-4% further dec

4、line in GDP in 2010 Inflation peaked to 12% in 2008 and 2009 (16% in 2009 without the housing component). Predicted to be 6% in 2010 The value if the ISK has decreased 50% against the euro in two years. The ISK is predicted to remain weak Unemployment has risen from 2,3% in 2007 to 7,2% in 2009. Eve

5、n higher rates are projected for 2010 Central government budget deficit has gone from 0% to 14% of GDB Gross government debts likely to exceed 100% of GDP.Source: Statistics Iceland, Central Bank of Iceland5678How the crisisoriginated and evolved A worldwide financial crisis started in 2007, caused

6、by a number of factors, e.g. Easy availability of low-interest loan capital during the 2000s. Resulted in classical asset and loan bubbles in many countries. Complicated by financial products that made valuations/risks difficult to determine (sub-prime lending, derivatives, etc.) while incentive pay

7、-schemes awarded short term profits and risk-taking appetite. Worldwide banking operations linked economies together making booms and depressions global instead of local.9 In Iceland Deregulation of financial markets in the 1990s (after Iceland joined the EEA). Privatization of banks in yearly 2000s

8、. Icelandic business and banks invested heavily abroad, often by leveraged buyouts. Stock market prices in Iceland quadrupled in 5 years. Huge govenment sponsored investment projects were launched during the 2000s (hydro-energy and aluminum smelting plants).10 In Iceland (cont.) Changes to the housi

9、ng loan system resulted in higher loan-to-value ratios and greater competition. Real estate prices doubled in 5 years. Lowering of tax ratios while increasing public expenditures (made everyone happy!) The CBI gradually increased its interest rates in order to stem inflation (its monetary policy bas

10、ed on inflation targets) Resulted in (1) businesses and homes seeking foreign loans, and (2) carry-trade as never seen before. Is inflation really always a bad thing?11 In Iceland (cont.) Homes increased their expenditures, partly paying for by higher incomes but also by loans. A shortage in the wor

11、k-force was met with foreign workers (proportion of foreign citizens living in Iceland increased from 3,5% in 2003 to 7,6% in 2009).12How the crisis evolvedIn early 2006 there was an Icelandic “mini-banking crisis” when CDS spreads increased and the banks were unable to seek funds for a while.Banker

12、s and the government agreed there was a lack of understanding about the Icelandic banks business model.Report by economist F. Mishkin at Columbia University was commissioned by the Chamber of Commerce to assure investors everything was safe and sound.Icelandic banks started to issue bonds in new mar

13、kets (the Americas, Asia) and especially offering high-interest deposits through their branches and subsidiaries in Europe.Confidence was bolstered when the “assault had been halted”.During 2007 financial markets were starting to panic because of sub-prime lending, dubious CDOs, etc. and it became i

14、ncreasingly difficult and expensive to obtain capital. In March 2008 the investment bank Bear Stearns collapsed. Funding for the Icelandic banks again dried up as their CDS rose to new levels.At the same time the ISK started to decline sharply as investors became increasingly worried.The Icelandic b

15、anks had to depend on short time funds from the ECB and CBI. The CBI sought in wane to assure reserve funds.After the Lehman Brothers collapse in September 2008 it became obvious one or more of the Icelandic banks would become illiquid and default. One bank (Glitnir) sought assistance from the CBI.A

16、t the beginning of October the three largest banks collapsed. The banking system had become too large to save. Events surrounding their collapse are still somewhat unclear with a lot of the blame game still going on.13 Kaarlo Jnnris Report on Banking Regulation and Supervision in Iceland (March 2009

17、): The collapse of the Icelandic banking sector resulted from a combination of several factors: Bad banking Bad policies Bad luckhttp:/eng.forsaetisraduneyti.is/media/frettir/KaarloJannari_2009.pdf14 Bad banking The owners and managers of banks adopted an aggressive policy of rapid international gro

18、wth based on high leverage and investment in growth areas that turned into bubbles. In the euphoric stage of rapid growth, risk controls and contingency plans were considered a nuisance, and the quality of the banks assets and the collateral used to protect them did not withstand the pressure when t

19、he prevailing emotion in the overheated global financial market turned from greed to fear. Icelands government and central bank were unable to support the overgrown banking sector in its difficulties. The banks had grown too big for Iceland.1516 Bad policies The money and financial market in Iceland

20、 is highly indexed or foreign exchange-based. As a result, the CBIs monetary policy only affects a small fraction of the financial system. The high degree of foreign currency denominated lending domestically also made the economy susceptible to fluctuations in the external value of the Icelandic krn

21、a. During the boom years, macroeconomic policies in general were too lax and accommodating. The CBIs foreign exchange reserves could not grow in tandem with the economys overall dependency on international developments. In addition, the CBIs human resources may have been too small for a country with

22、 a freely floating currency and a large banking system that was more international than domestic but was nonetheless viewed by foreigners as Icelandic.17 Bad policies (cont.) The FME Icelands financial regulator, was too small to supervise a complex banking system like that in Iceland. The powers of

23、 the supervisors were too limited, and the Nordic tradition of jurisprudence did not allow much leeway into discretion. The tycoons of the financial system could circumvent the underlying purpose of the regulations by sticking to the letter of the law with the help of diligent lawyers and complicate

24、d corporate structures. The supervisors were too timid and lacked legal authority in their efforts to intervene in these developments, but the overall national pride in the success of the banks would probably have made it futile even to try while the going was good and success followed success.18 Ba

25、d luck Since the Great Depression of the 1930s, the modern world has not seen a financial global crisis like the one we are experiencing right now. In these circumstances, the efforts of the Icelandic banks to retrench in late 2007 and 2008 were rather futile. Finally, the collapse of Lehman Brother

26、s on September 15, 2008 struck the final blow to the ability of the Icelandic banks and the authorities to save the system. There might just might have been a possibility for the Icelandic banks to survive if the almost total freezing of the international financial markets had not taken place and co

27、nfidence in Iceland had not been lost. Even in that case, they probably would have needed government support to maintain their solvency, as credit losses would have risen due to the deterioration of their loan portfolios. Now that the blaming game continues at high speed in Iceland, it is perhaps be

28、neficial to bear in mind that most, if not all, Icelandic players in this game must also look in the mirror. Placing the blame solely on external circumstances is not appropriate.19Anything new under the Sun? The causes of the Nordic banking crises Bad banking Inadequate market discipline Weak banki

29、ng regulation and supervision, Inadequate macro policies, including having to deal with financial liberalization.Stefan Ingves, at a seminar on the Nordic banking crises hosted by Kredittilsynet, in Oslo in September 2002./external/np/speeches/2002/091102.htm20What measures were tak

30、enThe government introduced an “emergency legislation” enabling the financial regulator (FME) to take over control of the banks and the establishment of new banks.The idea was to “ringfence” domestic bank operations.This was mostly successful but authorities seem to have misjudged reactions by forei

31、gn creditors and esp. foreign governments.Iceland was forced to seek assistance from the IMF and the Nordic countries, the first Western European country to do so since 1976. This move was hugely unpopular by many even if IMF has been rather “soft” on Iceland (except maybe the Icesave settlement).Ca

32、pital controls were introduced in November 2009 as a temporarily measures but still remain in force with no obvious escape plan.21Issues related to deposit insurance guarantees stemming from Landsbankis operations in the UK and the Netherlands (Icesave accounts) have been difficult to resolve. Repea

33、ted discussions have yet to result in a final agreement. This also has become a hotly debated political issue (with parties changing agendas depending on if they are in government or it the opposition).Inquiries and criminal investigations are taking place. Widespread distrust by the general public

34、towards politicians and bankers.A challenging task ahead to preserve the integrity and trust in the legal system (foreign creditors unhappy and accuse the government of discrimination).High expectations by the public towards the government to “solve their problems”. (But would this be a crisis if th

35、ey were easily solved?)Classical counter-depression measures with deficit spending not possible or appropiate.No political consensus on the way ahead when it comes to EU membership, monetary policy and other major issues!22 Restoring the banking system New banks were established to take over domesti

36、c operations. Only domestic deposits and assets were transferred to them. Settlement between the new and old banks has taken a lot longer than expected (valuation and negociations). Eventually the old banks took over two the new banks (will be operated as subsidiaries) while the government retains o

37、wnership of the largest bank. Bankrupcy laws were changed to accomotate for a continuing but limited operations of the old banks. Dissatisfaction from many creditors of the old banks. Resolution committee have been criticized for lack of accountability (Who do they really represent? Conficts of inte

38、rests. Lack of trans-parency). A legal minefield concerning “ex post facto” laws and discrimination. Smaller banks (S&L) are still being restored.23 Measures to assist the banks debtors (business and homes) Many debtors have loans denominated in foreign currencies (there are some doubts on the l

39、egality of such lending). The government has repeatedly put a moratorium on foreclosures and introduced new legal measures than can be used instead of bankruptcy in some cases (greislualgun = skuldsanering). Banks are offering extensions of loans, giving discounts on remaining balance if loans are t

40、ransformed into ISK, etc. Banks are also heavily involved in the financial restructuring of businesses. Widespread distrust by the public and in the media on how things are being handled following the crash (e.g. about ownership and competition). The banks and the government have not been successful

41、 in creating trust about the way things are handled.24Dont be careless!“Your are just starting,“ Gran Persson said in a speech at the University of Iceland yesterday Dec 10, 2008 while on a short visit by invitation of the Associations of Investors. Persson discussed the banking crisis in Sweden in

42、the 90 and what Iceland could learn from Swedens experience. The government of Iceland needs to show strong fiscal discipline and cut the deficit.”“I did so and ended up as one of the most hated politicians in Sweden for a number of year, but it was worth it, as the other option was worse,” Persson

43、said.“You have no time to loose. Some people say restructuring the public finances should be delayed until next year. I think the IMF shares that opinion. But why loose a year? Why wait?” Persson asked.Morgundbladid, December 11, 2008.http:/www.mbl.is/mm/gagnasafn/grein.html?grein_id=125964825Almost

44、 a year laterAt yesterdays conference Nov 11, 2009, the government was also criticized by its financial advisor, Mats Josefsson.“It appears that the restoration of the economy is not being prioritized by the government these days. Lack of political decision-making is the main hindrance in the restor

45、ation of the Icelandic economy,” he said ”.He also told that the main weakness in the governments restructuring was than no single entity was responsible for decision making. Actions need to be coordinated and in order to create more trust a single entity should be responsible to give information to

46、 the public and to creditors.Iceland Reviewhttp:/ the INAO was affected New tasks Participating in the audit of the new banks while they remain in goverment ownership (only temporarily) Giving opinions on budget proposals More frequent monitoring of the budget execution New audit tasks in financial

47、management, mergers, procurments, hiring practices etc. A role in monitoring fiscal affairs of municipalities? All while cutting costs by 10% due to lesser appropriations!27Challenges and lessons learned A the macro level A sound economic policy (fiscal and monetary) is important also during good times. A strong fiscal discipline is always needed. Managing a floating exchange rate, inflation targets and interest rates is difficult (and even dangerous) esp. in a small open economy (has be