2008–2012 Icelandic Financial Crisis

2008–2012 Icelandic Financial Crisis

The 2008–2011 Icelandic financial crisis was a major economic and political crisis in Iceland that involved the collapse of all three of the country's major privately owned commercial banks, following their difficulties in refinancing their short-term debt and a run on deposits in the Netherlands and the United Kingdom. Relative to the size of its economy, Iceland’s systemic banking collapse is the largest suffered by any country in economic history.

In late September 2008, it was announced that the Glitnir bank would be nationalised. The following week on 7 October 2008, control of Landsbanki and Glitnir was handed over to receivers appointed by the Financial Supervisory Authority (FME). Two days later, the same organization placed Iceland's largest bank, Kaupthing, into receivership as well. Commenting on the need for emergency measures, Prime Minister Geir Haarde said on 6 October, "There a very real danger... that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could have been national bankruptcy." He also stated that the actions taken by the government had ensured that the Icelandic state would not actually go bankrupt. At the end of the second quarter 2008, Iceland's external debt was 9.553 trillion Icelandic krónur (€50 billion), more than 80% of which was held by the banking sector. This value compares with Iceland's 2007 gross domestic product of 1.293 trillion krónur (€8.5 billion). The assets of the three banks taken under the control of the FME totaled 14.437 trillion krónur at the end of the second quarter 2008, equal to more than 11 times of the Icelandic GDP, and hence there was no possibility for the Icelandic Central Bank to step in as a last lender of resort when they were hit by financial troubles and started to account asset losses. As part of the urgently passed emergency law on 6 October, the path forward for the receivership held banks was dictated to be a secretion of all domestic assets into new surviving public owned domestic versions of the banks, while leaving the foreign remainings of the banks into receivership and liquidation. This move worked as a protecting hand for the Icelandic economy, as it meant that the domestic residents would not suffer any losses from the systemic bank failure.

However, the financial crisis still had a serious negative impact on the Icelandic economy. The national currency fell sharply in value, foreign currency transactions were virtually suspended for weeks, and the market capitalisation of the Icelandic stock exchange fell by more than 90%. As a result of the crisis, Iceland underwent a severe economic recession; the nation's gross domestic product (GDP) dropped by 5.5% in real terms in the first six months of 2010. Outside Iceland, more than half a million depositors (far more than the entire population of Iceland) found their bank accounts frozen, as a result of the foreign branches of the three Icelandic banks were thrown into receivership; and a subsequent diplomatic dispute (known as the Icesave dispute) also evolved over repayment of deposit insurance between Iceland at one side versus United Kingdom and the Netherlands.

The main countermeasures to combat the crisis were:

• Enforcement of strict capital controls (incl. a temporary suspension of all official currency exchange) on 6 October 2008 - to help protect the ISK currency.
• Activation on 17 November 2008 of a $5.1bn big sovereign bailout package (of which $2.1bn came from IMF and the remaining $3.0bn from a group of Nordic countries) - to help finance budget deficits and the creation of domestic banks.
• Implementation of austerity measures as part of the needed fiscal consolidation.
• Activation of "Minimum deposit guarantee repayment loans" (€1.2bn from Germany; while the €4.0bn of offered Icesave loans from UK and Netherlands never was accepted) - to help finance the minimum deposit repayment to foreign account holders having lost their savings due to the bankruptcy of the Icelandic banks.

The window with bailout support for the Icelandic state officially ended on 31 August 2011, without being extended with new extra loans or Precautionary Conditioned Credit Lines. As originally planned by IMF, Iceland instead managed indeed to regain complete access to financial markets to cover its future funding needs, and in first half of 2012 started to repay some of the established bailout debt. As of January 2013, the enforced capital controls is however still needed to protect the currency, and although it is being recommended by IMF to be lifted (in order to pave the way for foreign investments entering into the Icelandic territory), they also preach it should not happen before the Balance of Payments is entirely stable and the central bank has succeeded to build up a substantial foreign capital reserve (or sterilized some excessive amounts of ISK in circulation). In regards of repayment of minimum deposit guarantees, all these amounts have now also been repaid through the liquidation of assets by the receiverships for all three bankrupt banks; which was possible because the Icelandic law grant an exclusive first priority for repayment of these guarantees before the remaining priority claims and general claims from creditors are dealt with. A new era with positive GDP growth started in 2011, and has helped foster a gradually declining trend for the unemployment rate. The government budget deficit after being up at 10% of GDP in 2009 and 2010, has now also been brought back to a more acceptable level at 3.4% of GDP in 2012; which along the way created the basis for the debt-to-GDP ratio to decline from its maximum at 101% in 2011 to 97% in 2012. The remaining challenges for the economy as of January 2013, is to lower its relatively high level of HICP inflation rate (which increased to 6.0% in 2012), and to lower the depreciation pressures against its national currency.

The Icelandic Financial Crisis is commonly referred to have officially ended 31 August 2011, which was the day where the international bailout support programme led by IMF officially ended. A free market perspective might add, however, that capital controls would need to be lifted for Iceland to be considered to have fully overcome its crisis.