Do some policy options make it easier to lift the controls than others? Which comes first, lifting the controls or deciding the currency issue? At what exchange rate should so-called offshore krónur be converted if Iceland establishes a currency board or adopts another currency unilaterally? Is it possible that capital account liberalisation will wait until – or even beyond – accession to the EU? These questions are not easy to answer, and exhaustive answers are beyond the scope of this report, but a few points can be made nonetheless. The most desirable option must be to lift the controls before deciding the currency issue. First of all, Iceland needs to lift them – for its own sake and due to international obligations – and the process has already begun. Second, it appears clear that either the controls must be lifted before Iceland adopts another currency or establishes a currency board, or onshore and offshore krónur must be converted at the same exchange rate. Any other course could be considered default, with severe repercussions for Iceland’s future access to foreign credit markets. Third, the EU regulatory framework assumes that capital controls will be lifted prior to membership. 10  BIS central bankers’ speeches  If liberalisation proves so difficult that Iceland cannot achieve it without outside assistance – which hopefully will not be the case – the most straightforward solution would be to refer the problem to the EEA, as free movement of capital is provided for in the EEA Agreement.
Depending on the resolution there and the progress of the EU accession negotiations, the problem could be resolved in connection with the accession process itself. At this point, it is unclear what form such outside assistance would take, but the more it takes the form of declarations concerning limits to exchange rate fluctuations backed by credibility and strong ability to intervene in the foreign exchange market, and the less it takes the form of offering loans, the better. On the other hand, it appears inevitable that, if Iceland joins the euro area, it would be necessary to convert all krónur at the same exchange rate, for the same reasons as with a currency board or unilateral adoption of another currency. Although the interaction between the capital controls and Iceland’s currency options is complex in many respects, this is not true to the same extent of prudential rules restricting the international activities of domestic financial institutions. For instance, it would be safe to relax such rules if Iceland were a member of the euro area and its financial institutions could carry out a large share of its cross-border business in its home currency. This would be even more true if the EU framework for cross-border banking were reformed so as to provide for EU supervision of banks operating throughout the region, a pan-European deposit insurance scheme, and intervention in distressed financial institutions by a joint EU body.