The macroeconomic adjustment and rebalancing was unavoidable and was facilitated over time by the real depreciation of the currency. The shocks disproportionally affected overblown sectors (banking and construction), whereas most of the export base remained intact. Much of the impact of the banking collapse hit countries other than Iceland. Another important reason was the policy responses that mitigated the recession and promoted recovery. Let me now turn to those. The policy responses took two main forms: crisis management during the collapse of the banks and the economic programme developed by the Icelandic authorities in co-operation with the IMF. From at least early 2008, the Icelandic authorities were aware of potential foreign currency liquidity problems at the banks and took action by trying to negotiate swap lines and tap foreign capital markets – in both cases, with limited success. Given the lack of international cooperation, the Icelandic authorities were forced to consider radical solutions when the banks failed. Although they were not necessarily articulated in full at the time, these solutions entailed several goals: to preserve a functioning domestic payment system, ring-fence the state in the case of bank failures, limit the socialisation of private sector losses, and create the conditions for rebuilding a domestic banking system. The adopted solution was embedded in the so-called Emergency Act, which was passed by Parliament on 6 October 2008. The Emergency Act saved the domestic operations of the banking system by creating new banks, which involved carving domestic assets and liabilities out of the old, failing banks.
These currently total 14½% of GDP, after having been more than halved through auctions, bilateral deals and nominal GDP growth since capital controls were introduced. 4  BIS central bankers’ speeches  Therefore, potential capital outflows amounting to almost 40% of GDP might have sought a speedy exit if capital controls had been lifted overnight. This would have had serious consequences for economic and financial stability in Iceland. This was not going to be allowed to happen and, as a matter of fact, the population has been promised solutions entailing no negative effect on the exchange rate. A co-operative solution vis-à-vis the failed bank’s estates that allows them to go into composition and pay out to creditors by fulfilling so-called stability criteria has been decided and is being implemented. Had that not been forthcoming, we would have had to impose a one-off stability tax of around 31% to deal with the externality, as we could no longer hold the Icelandic nation hostage to the situation. The stability criteria are these: the estates pay stability contributions by transferring a significant part of their króna assets to the government, lengthen the maturity of current FX financing of domestic banks, repay government and central bank support and debt. Taken together, these measures fully mitigate the potential negative balance of payments effect from unwinding the estates.