Iceland’s handling of its recent bank crisis is widely misunderstood, say its policymakers
To many outsiders Iceland stands for the idea of dealing with a dramatic financial crisis by letting banks fail and then devaluing the currency.
The country even managed to convince the International Monetary Fund of the benefits of capital controls.
But Icelandic policymakers say much of that view of an “Icelandic model” for handling a financial collapse is a myth – even as it is invoked as a possible template for Cyprus’s international rescue.
“Is there an Icelandic model for dealing with failing banks? My conclusion is mostly no,” says Mar Gudmundsson, the governor of Sedlabanki, the central bank. “There is a lot of misunderstanding about Iceland.”
The confusion comes because in 2008 Iceland’s three largest banks – Kaupthing, Landsbanki and Glitnir, which together had assets 10 times the size of the economy – were allowed to fail.
Rather than bailing them out and protecting bondholders, as did countries such as Ireland, Iceland forced losses on to the bank’s creditors.
In the popular imagination – particularly in Ireland, Portugal and Spain – this meant the government avoided the bill for the financial implosion.
But that is not true. Iceland, in fact, spent more as a percentage of gross domestic product than any other country apart from Ireland in rescuing its banks, according to the OECD.
Two Icelandic experts have estimated that the crisis cost Icelandic taxpayers 20-25 per cent of GDP, principally because of a loss in the value of collateral that the three collapsed banks had pledged to the central bank when the authorities were trying to save them.
Gudmundsson stresses that the domestic banking and payment system continued without interruption. The three banks “were more off-border than cross-border”, he points out, meaning the economic consequences of the collapse of 90 per cent of the financial system were less dramatic than they might have been.
“It is a myth that Iceland allowed banks to fail completely and that other countries could do the same without feeling consequences,” he adds.
The issue of foreign creditors has not gone away either. Most of their claims are owned by hedge funds, banks or restructuring specialists, opening them up to attack from the centre-right opposition who are threatening to pay them back very little.
Exchange rate
Another debating point is the merit or otherwise of Iceland having its own currency.
Iceland took much of its pain through the exchange rate rather than the unemployment rate – the krona fell by more than 50 per cent against the euro.
But by boosting the cost of imported goods and thus consumer prices, the sinking currency has been a double-edged sword, as most Icelandic loans are linked to inflation.
The boost to exports from the falling currency has not been as great as many predicted, Gudmundsson says. “The level [of the krona] does give stimulus to exports, that is absolutely true. But export growth has been lower than you would expect given the depreciation.
“Even if you depreciate the exchange rate, you can’t create more fish.”
This has led to a debate about adopting another currency, with the euro as a favourite.
A related myth for some Icelanders is that capital controls – restrictions on the flow of currency in and out of the country – have been a success. Gudmundsson calls them “in some sense” Iceland’s version of quantitative easing (QE) in putting a floor under asset prices.
But, as with QE, many wonder if it is easier to establish capital controls than dismantle them. Vilhjalmur Egilsson, head of the Confederation of Icelandic Employers, says: “They were a big mistake. There is no exit strategy.”
Role model
Doubts may exist about whether Iceland and its crisis policies can serve as a model for others. But, for Katrin Juliusdottir, finance minister, there is little doubt that it was the right course.
“It was the right way to do it for Iceland . . . Hopefully we can learn from it. A lot of mistakes were made,” she says. – (Copyright The Financial Times Limited 2013)
