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Iceland: The Financial and Economic Crisis

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  • David Carey

    (OECD)

Abstract

The global financial and economic crisis has struck Iceland with extreme force. Iceland’s three main banks, accounting for almost all of the banking system, failed in October 2008. They were unable to resist the deterioration in global financial markets following the failure of Lehman Brothers. The banks had pursued risky expansion strategies – notably borrowing in foreign capital markets to finance the aggressive international expansion of Icelandic investment companies – that made them vulnerable to the deterioration in global financial markets. They had also grown to be too big for the government to rescue. When access to foreign capital eventually closed, the banks failed. Non-financial firms and households were also vulnerable to the deterioration in global financial conditions, having taken on a lot of debt in recent years based on inflated collateral values. In some cases, the debt was foreign-currency denominated, without matching foreign-currency assets or revenues. In the wake of the banking crisis, the government obtained an IMF Stand-By Arrangement to provide favourable access to foreign capital markets and creditability for the recovery programme. Even so, the recession is likely to be deeper in Iceland than in most other OECD countries owing to the seriousness of the banking crisis and the weakness of private sector balance sheets. Reforms are needed to strengthen prudential regulation and supervision. This Working Paper relates to the 2009 Economic Survey of Iceland. Islande : La crise économique et financière La crise économique et financière mondiale a frappé l’Islande avec une violence extrême. Les trois principales banques du pays, qui représentaient pratiquement l’ensemble du système bancaire, ont fait faillite en octobre 2008. Elles n’ont pas réussi à résister à la détérioration des marchés de capitaux mondiaux dans le sillage de la faillite de Lehman Brothers. Les banques avaient suivi des stratégies de développement risquées – empruntant notamment sur des marchés financiers étrangers pour soutenir une expansion internationale dynamique des sociétés d’investissement islandaises – ce qui les a rendues vulnérables à la détérioration des marchés de capitaux mondiaux. Elles avaient également atteint une taille trop importante pour que le gouvernement puisse venir à leur rescousse. Lorsque l’accès aux capitaux étrangers a été finalement fermé, les banques ont fait faillite. Les entreprises non financières et les ménages – qui s’étaient massivement endettés ces dernières années profitant de la forte valorisation de leurs garanties – étaient aussi vulnérables à la détérioration de la situation financière mondiale. Dans certains cas, la dette était libellée en devises sans que les emprunteurs n’aient d’actifs ou de revenus dans ces devises susceptibles de compenser le risque de change. À la suite de la crise du système bancaire, les pouvoirs publics ont conclu un accord de confirmation avec le FMI pour assurer des conditions d’accès favorables aux marchés de capitaux étrangers et soutenir la crédibilité du programme de redressement économique. Malgré cela, il est probable que la récession sera plus profonde en Islande que dans la plupart des autres pays de l’OCDE en raison de la gravité de la crise bancaire et de la faiblesse des bilans des entreprises et des patrimoines des ménages dans le secteur privé. Des réformes sont nécessaires pour renforcer la réglementation et la surveillance prudentielle.

Suggested Citation

  • David Carey, 2009. "Iceland: The Financial and Economic Crisis," OECD Economics Department Working Papers 725, OECD Publishing.
  • Handle: RePEc:oec:ecoaaa:725-en
    DOI: 10.1787/221071065826
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    File URL: https://doi.org/10.1787/221071065826
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    References listed on IDEAS

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    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(3), pages 291-299, September.
    2. Frederic S. Mishkin, 2009. "Globalization, Macroeconomic Performance, and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 187-196, February.
    3. Andrea de Michelis, 2009. "Iceland: Challenging Times for Monetary and Fiscal Policies," OECD Economics Department Working Papers 726, OECD Publishing.
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    Cited by:

    1. Gábor Regős & Xibin Zhang, 2015. "Modeling the exchange rate using price levels and country risk," Cogent Economics & Finance, Taylor & Francis Journals, vol. 3(1), pages 1056928-105, December.
    2. Bruno Martorano, 2014. "Is it possible to adjust ‘with a human face’? Differences in fiscal consolidation strategies between Hungary and Iceland," Papers inwopa719, Innocenti Working Papers.
    3. Aitor Erce, 2015. "Bank and sovereign risk feedback loops," Globalization Institute Working Papers 227, Federal Reserve Bank of Dallas.
    4. Irina Balteanu & Aitor Erce, 2014. "Bank crises and sovereign defaults in emerging markets: exploring the links," Globalization Institute Working Papers 184, Federal Reserve Bank of Dallas.

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    More about this item

    Keywords

    accord de confirmation avec le FMI; banking crisis; credit-induced asset price boom; crise bancaire; crise financière; crise monétaire; currency crisis; deleveraging; envolée du cours des actions induite par le crédit; financial crisis; foreign exchange exposure; Iceland; IMF stand-by arrangement; international investment position; investment companies; Islande; macro-prudential supervision; micro-prudential supervision; position d’investissements internationaux; prudential supervision and regulation; réduction de l’effet de levier; sociétés d’investissement; surveillance et réglementation prudentielle; surveillance macro-prudentielle; surveillance micro-prudentielle;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand

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