Ingimundur Friðriksson: The banking crisis in Iceland in 2008 Paper by Mr Ingimundur Friðriksson, Governor of the Central Bank of Iceland, prepared for a seminar which was scheduled to be held at the Bank of Finland, 6 February 2009. The author was unable to attend. * * * Iceland has been hit extraordinarily hard by the financial crisis that has swept across the globe. The rapid growth of the country’s financial system in the past few years rendered it much more vulnerable to global developments than it would otherwise have been. In my talk today, I would like to trace in broad terms various aspects of the runup to the Icelandic banking crisis, particularly from the point of view of the Central Bank. It will not be a complete picture. After Iceland’s banks were fully privatised early this century, they began expanding at a rapid pace, with the primary focus of that growth outside Iceland. They acquired financial companies in other countries, opened branches, and expanded their international business from their headquarters in Reykjavík. This rapid growth was facilitated by Iceland’s membership in the European Economic Area (EEA) through which the country had created for its financial system a regulatory framework that was rooted in the directives adopted by the European Union. Among other things, this meant that operating licences granted to Icelandic financial companies extended not only to Iceland but to all other EEA states. For example, they were permitted to operate branches anywhere in the EEA.
They took advantage of a liberal regulatory environment, good credit ratings, and the unusually advantageous conditions on the global markets and expanded their operations at a rapid pace. The European regulatory framework made this possible. In many ways their activities resembled those of banks in other countries. Under normal market conditions, this posed no immediate problem. The banks could have funded their operations even under sub-optimal market conditions. Many were of the opinion that the Central Bank should build up very large foreign exchange reserves, even up to a multiple of GDP, in order to back up the financial system. Given the current account deficit on the balance of payments, this would only have been possible with massive foreign borrowing. It would never have transpired, for the simple reason that the Icelandic government would have been unable to borrow such a large amount. Its credit ratings would not have tolerated it, and lenders would have been difficult to find. As I have touched on, the banks responded to mounting difficulties in various ways. Kaupthing, for example, abandoned its plans to acquire the Dutch bank NIBC. All of the  6  BIS Review 22/2009  banks sold assets and discontinued various non-core operations; however, as the IMF mentioned in the previously cited Staff Report, it was not a seller’s market. In addition, the banks all reduced their lending and laid off staff.