The Collapse of Icesave In 2006, Landsbanki – one of Iceland’s three major banks – officially announced the launch of a new project: Icesave. Icesave, a new brand to be operated by Landsbanki, was designed to offer online savings accounts with low commitment, ease of access, and high interest rates in both the United Kingdom and the Netherlands (Landsbanki Annual Report 2007). In the UK, the interest rates were higher than 6%10; in the Netherlands, 5. 25%11.
As more evidence of the Icelandic banks’ extreme risk levels was revealed, however, fear consumed those who had deposits in Landsbanki. The speculation of the Icelandic banks, in conjunction with ensuing global financial crisis, sparked a run on the bank in the UK – a run on the bank that marked the demise of Landsbanki. The Icelandic Parliament issued Act No. 125/2008 on October 6, 2008, in which the Icelandic government took Landsbanki under its control as a result of “unusual and extraordinary circumstances on the financial market. 18 The Icelandic Government also stated “that deposits in domestic commercial and savings banks and its branches in Iceland will be fully covered,” making no mention of the British or Dutch deposits in the Icesave accounts12.
On October 7, Landsbanki was placed on receivership by the Icelandic government. The FME, Iceland’s Financial Supervisory Authority, clearly stated that the objective of taking control of Landsbanki was “to guarantee a functioning domestic banking system. The bank would operate as usual, and domestic deposits were fully guaranteed, but Iceland once again failed to make a mention the bank’s foreign deposits13. Iceland moved all of Landsbanki’s domestic assets and liabilities to a new government-owned bank, Nyi Landsbanki.
The Icesave accounts and any other foreign assets and liabilities remained under the old Landsbanki, which now had to pay off €22. 2 billion of liabilities with only €12. 1 billion in assets14. The Icesave dispute had officially begun. The EU’s relationship with Iceland Though Iceland is rather alienated from the European Union geographically, it as had frequent political and financial involvement with the EU over the last 40 years.
54% of Iceland’s imports are from EU-member countries, and 76% of its exports go to EU-member countries16. Iceland is included in the Schengen area, an area of over 4 million square kilometres, which allows freedom of internal travel. Since Iceland is already in agreement with Schengen protocols, issues regarding common policies on the temporary entry of persons, harmonisation of external border controls, cross-border police and judicial co-operation are avoided.According to the European Commission’s Opinion on Iceland’s application for membership of the European Union, “the Commission recommends that negotiations for the accession to the European Union should be opened with Iceland. ” The Commission formed its opinion by analyzing Iceland’s ability to satisfy three important economic and political conditions defined by the Copenhagen criteria: 1. Firstly, the new Member State must achieve “stability of institutions guaranteeing democracy, the rule of law, as well as human rights and respect for and protection of minorities.
” 2.Secondly, the “existence of a functioning market economy and the capacity to cope with competitive pressure and market forces within the Union” must be present. 3. Thirdly, the country must have the “ability to take on obligations of membership including adherence to aims of political, economic and monetary union.
” The political criteria were seen as satisfied overall, and the economic criteria and ability to adapt to the EU’s policies were also seen as generally satisfied, providing that Iceland “swiftly implements the necessary policy measures and structural reforms” 16.However, Iceland’s recent financial crisis calls for a re-evaluation of the Commission’s opinion. Iceland’s dispute with the United Kingdom and the Netherlands over the loss of deposits in Icesave online accounts has brought into question Iceland’s ability to satisfy these criteria. Despite the disputes over EU directives and damage to the Icelandic economy as a result of the collapse of Icesave, Iceland will be able to comply with the Copenhagen criteria; therefore, Iceland should still be considered for accession into the European Union.Stability of Institutions: Government Regulation According to the EU Commission’s preliminary research, “the national authorities [in Iceland] are responsible for the implementation of programmes and the proper use of EU finances…[Iceland’s] Ministry of Finance is responsible for issuing regulations regarding the execution of the general budget and for the financial management of the state”16. However, in the face of the financial crisis brought on by the collapse of Icesave, the weakness in Iceland’s Ministry of Finance and national authorities was revealed.
The Icelandic government was unprepared to pay back depositors in event of such a massive recession because of the privatization of banking insurance. The ‘Icelandic Depositors' and Investors' Guarantee Fund,' a private institution that insures commercial banks, savings banks, investment services and security trading firms established in Iceland, was responsible for guaranteeing the deposits in Landsbanki and other private banks, rather than a public institution like the government. At the time of Landsbanki's collapse, the Fund had equity of only about €68 million, which was far from sufficient to cover the €3. billion in Dutch and British claims9. The privatization of Iceland’s three major banks in 2003 also led to weaker government regulation.
Now under the control of the shareholders, the banks began to lend money more aggressively to firms, holding companies, and foreign parties. According to an analysis of the morality and work practices in Iceland leading up the recession, a Working Group on Ethics reported that “in the wake of a flawed process of privatization, where inexperienced owners gained large shares, the banks [in Iceland] were allowed to grow far beyond [the owners] ability to supervise them properly. 15 Unfortunately, overwhelming demand around the world for these high-interest Icelandic banks only encouraged more irresponsible banking policies – until the banks finally collapsed. While the Icelandic government cannot be blamed for the poor decisions of the banks’ CEOs, its resistance to step in and slow down the growth of the banks was irresponsible.
What appeared to be an increase in strength of the banking systems dissuaded politicians and government supervisors from stepping in, but in reality it should have alarmed them.As the Special Investigations Commission for the Icelandic Parliament stated in the summary of its investigations, “such large-scale and high-risk growth is not compatible with the long-term interests of solid banks” 15. A closer look at the banks’ assets reveals a reliance on weak equity, assets based on borrowing from the system itself, resulting in a lack of stability15. The Icelandic government should have recognized this sooner, and taken action to prevent the economic crisis.Fortunately, Iceland’s weak financial control is not a completely new issue in the eyes of the EU. As The EU Commission had already stated in earlier research, “Iceland will need to make serious efforts” to improve its financial control, and “Iceland should be able to cope…provided it swiftly implements the necessary policy measures and structural reforms” 16.
Iceland has already taken steps in this direction by placing its three major banks on receivership and transferring many of their assets to the government.So long as Iceland continues to improve its financial control, they should have no problem complying with the EU’s standards. Fulfilling Membership Obligations: EU Directives and Negotiations As a member of the EEA (European Economic Area), Iceland is obligated to follow many EU directives. One EU directive that Iceland is obligated to follow guarantees that all bank depositors are insured up to €20,000 and that “all nations must make sure they guarantee that insurance without question. 17 However, Iceland’s attempts to interpret these directives differently lead to difficult negotiations with the UK and the Netherlands.
The Icelandic government officials were uncooperative and unaccommodating with the British and Dutch governments, and made strong attempts to avoid following the EU directives. Officials from the UK Treasury met with the Icelandic Minister for Business Affairs in early October, 2008, to discuss the bank’s operations, where Icelandic Financial Minister Arni M.Mathiesen stated that the Icelandic Government would insure the deposits and provide necessary funds, in order to meet the minimum compensation limits in the event of a failure of Landsbanki. However, soon after Landsbanki had been placed into receivership, it was stated by Mathiesen that Icelandic government was only obligated to guarantee deposits in the banks and branches in Iceland23. Such attempts to avoid obligations cannot be tolerated by the EU. However, while its attempts to evade responsibility can’t be completely excused, Iceland’s economic condition makes its reaction understandable.
As was stated in the Icelandic Parliament’s Bill amending Act No 96/2009, “The heavy and extensive debts of public entities and private parties is currently a serious problem in the Icelandic economy…In many respects, the current lack of loan capital and risk capital is a more serious issue for the Icelandic economy than heavy indebtedness. ”19 The EU can understand Iceland’s decision to prioritize its own welfare above that of the UK and the Netherlands; most countries in the EU would look out for their own welfare first and foremost.The settlements of these obligations became the center of debate between Iceland and the UK and Netherlands. The Netherlands and Britain had repaid its respective depositors the equivalent of €20,887 (the domestic Icelandic guarantee amount), expecting to be repaid by the Icelandic Government24. Iceland went back and forth with the British and Dutch governments, as well as within its own government, amending the bill to benefit all three parties as much as possible.
The Icelandic President’s concern for protecting the Icelandic people slowed down negotiations, while the Icelandic Parliament’s concern for fulfilling its obligations to the UK and the Netherlands demonstrates Iceland’s potential to balance its National obligations and its obligations to the EU. Although President Olafur Ragnar Grimsson’s concern for the welfare of his country is admirable, his unwillingness to cooperate was the reason that negotiations on the Icesave dispute were so difficult.He made his decision to rejected Parliament’s 14-year repayment plan out of the interests of the Icelandic people, claiming "we [the Icelandic State] do not intend to pay the debts of the banks that have been a little heedless. ”7 He clearly understood the will of the nation, evident by the 93% rejection by the Icelandic people of the bill’s referendum in March 20108.
However, Grimsson refused to acknowledge his country’s responsibility under the EEA, an unreasonable stance counterproductive to a final solution. However, in the face of pressure from the British and Dutch overnments, the Icelandic Parliament has recognized its obligation to pay back its loans as soon as possible. In August 2009, an agreement was reached between the Icelandic, Dutch and British governments and a bill passed on to the Icelandic parliament23. When the British and Dutch governments did not accept this amended bill and blocked the IMF’s loan to Iceland, the Icelandic Parliament passed a further amended version of the bill in December 2009 to ensure complete payment to the two countries within the next 14 years25.Though the countries haven’t settled on a final agreement, the dispute has shown Iceland’s ability to negotiate with EU members.
Existence of a Functioning Market: Iceland’s Market Stability The collapse of the financial sector in Iceland put into a terrible position. The collapse completed devalued their currency, the krona, which then in turned put upward pressure on prices of imports from the EU4. This has dropped domestic consumption and has halved domestic investment4, both of which contributed to the 6. 1% GDP contraction in Iceland in 20093.
For a country such as Iceland that depends so heavily on international trade and imports from the EU2, this is a highly dangerous situation. Exports from Iceland have dropped in the past year-to-year3, but in the future it is likely that exports will drive the resurrection of the Icelandic economy. This is because of the devaluation of krona made Icelandic made goods cheaper to purchase by consumers using the Euro. Debt repayment will create a problem as the Iceland’s governmental debt is now estimated to be 300% of their GDP4.The weakened krona will also only make it more difficult to pay back debt owed in other denominations. Credit situations are also tough as firms and consumers alike are finding it hard to receive loans or credit.
The Central Bank of Iceland raised interest rates to 7% as of November 20106; therefore, consumption and investment dropped as high interest rates forced out potential investors unable to make these high returns necessary. A natural corrector to this conundrum is that high interest rates will encourage foreign investors to inject liquidity into the market seeking high returns on their investment.Normally this would be the case and liquidity would be restored in the market, but foreign investors are unsure about the volatile Iceland krona. If economic growth is going to be made possible, interest rates must be lowered and liquidity must be returned to the market. Iceland’s liquidity will only improve when foreign investors regain faith in Iceland’s economy.
That faith can only be restored with the stabilization of Iceland’s currency. Existence of a Functioning Market: Iceland’s CurrencySince the collapse of Iceland, another pressing point for Iceland has been its weak and volatile currency, the krona. As a low volume currency that is of little use outside of Iceland, one of the major reasons for Iceland’s membership application to the European Union is the use of its currency, the Euro. Iceland’s krona is notorious for its volatility versus the dollar and Euro. This was further exacerbated by the financial crisis of 2007.
Joining the European Union would mean possible usage of the Euro, if Iceland were to want to adopt it.This would also bring its notoriously high interest rates down, increasing investment and stimulating GDP growth. Findings from the Cambridge Journal of Economics suggest that the fusion of Iceland into the EU currency union could lead to a 60% increase in its trade, as foreign firms would no longer worry about losing profit through unbeneficial exchange rates20. Additionally, any problems with the stability of Iceland’s currency would end if Iceland adopts the Euro. Finally an increase in trade promoted by Euro use would be mutually beneficial for both Iceland and the other EU member countries.
