The saga of icesave a new cepr policy insight

Icelandic banks started experiencing increasing problems raising funds in international capital markets in 2006 and hit on the thought of establishing Internet banks in Europe. The European financial passport made that simple to accomplish, and the rating agencies favoured the move, see e.g. the Moody’s (2006) report.

As I explain in greater depth in CEPR Policy Insight No. 44, there are essentially two ways a bank can do that, by a branch or subsidiary. Landsbanki opted to create branches, beneath the name of Icesave, supervised and insured from Iceland. They offered above-market interest levels, starting in October 2006, eventually amassing £4.5 billion in the united kingdom. This may have already been done initially with the encouragement of the united kingdom FSA, being concerned about the funding position of Landsbanki.

In 2008, the FSA became concerned and applied increasing pressure on Landsbanki to limit deposits, to which it responded by needs to raise deposits in holland in-may 2008, eventually collecting €1.7 billion there.

International capital markets increasingly appear to have viewed the Icelandic banks and the federal government of Iceland as an individual joint entity from a risk viewpoint. The united states risk became effectively exactly like the lender risk.

The CDS spreads of Landsbanki started rising sharply in 2008, start to see the Figure, reaching 865 on if they started taking deposits in holland, and they dropped to 291 on 23 May, before reaching 715 by early August.

Figure 1 . CDS spreads on Landsbanki, 2007-2008

Singh and Spackman (2009) calculate the implied possibility of default for as 22%, using an assumption of 40% recovery, and 77% if using stochastic recovery and probability, a methodology they recommend.

By 2008 anybody with usage of Bloomberg could see that the CDS spreads on Landsbanki were between the highest in Europe for banks. The chance was widely discussed in media. That is Money in the united kingdom had articles on that placed Iceland’s banks atop the "riskiness league", saying “these [Icelandic] banks are actually viewed as the most unsafe in the developed world.” MoneyWeek in the united kingdom on had an identical story, stating “perhaps, just perhaps, we have to pay more focus on the chance side of the equation too.”

The relevant authorities were also alert to the precarious state of the Icelandic banks. For instance, Gunnarsson (2009) notes that in April 2008 ECB President Jean-Claude Trichet called the governor of Bank of Iceland in anger, complaining about the Icelandic banks. Gunnarsson (2009) states that Landsbanki was under close scrutiny by the relevant authorities in Europe, who applied pressure to limit deposits.

Landsbanki eventually collapsed in October 2008 combined with the remaining Icelandic financial system. Following the failure of Landsbanki, the federal government of the united kingdom fully compensated all retail depositors, as the government of Netherlands compensated retail depositors up to €100,000. However the first €21,000 fell on the Icelandic deposit insurance fund, which only contained a fraction of the needed amount.

Under EU law, if the deposit insurance fund isn’t sufficient, it falls on the other banks in the united states to create up the shortfall. However, regulations is unclear on what goes on if all the banks fail. See e.g. the Mishcon de Reya Solicitors report (2009).

This uncertainty may be the foundation of Iceland’s reluctance to pay the united kingdom and Netherlands. It hasn’t rejected its obligations but instead the terms under which Iceland compensates the united kingdom and Netherlands, which reaches the heart of the dispute.

The entire amount involved may not seem excessive, around €3.9 billion, but only around 315,000 people reside in Iceland, so that compatible about €13,000 per person. Factoring in recovery, the money flows schedule and accumulated interest payments, I estimate that, at current exchange rates, Iceland should be expected to pay €2.8 billion (Danielsson, 2010). That is slightly below its government’s total expenditures this year 2010.

Due to the structure of the offer, Iceland’s net payments increase if its economy performs badly. It really is already the most indebted country on the planet because of the crisis, and if the Icesave repayments become too burdensome, a sovereign default is a possible eventuality.

The EU has used its influence to carry up approval of IMF aid, and Iceland’s EU application is apparently depending on settlement. However, because the most Icelandic voters have consistently opposed EU membership, this pressure might not at not be all that effective.

The duty for Icesave falls jointly on Iceland, UK and holland. It is in the very best interests of most three governments, along with the IMF and the EU, to come quickly to an acceptable agreement, enabling Iceland to create good on its obligations, without tipping the economy in to the abyss.

Danielsson, J. (2010), "The Saga of Icesave," CEPR Policy Insight No. 44.

Danielsson, J. and Zoega, G. (2009), "Collapse of a country", mimeo.

Gunnarsson, Styrmir. (2009). Umsátrið.

Moody’s (2006), “Bank operating system outlook”, Report on the Icelandic bank operating system, December.

Singh, M. and Spackman, C. (2009). "THE UTILIZATION (and Abuse) of CDS Spreads During Distress," IMF Working Paper 09/62.