eFinancialCareers

What is it?

A small volcanic island in the North Atlantic with a big financial system. Although Iceland is home to only 320,000 people and had a gross domestic product (GDP) of only $19bn in 2007, its banks were very active on the world stage. In September 2008, its three biggest banks (Kaupthing, Landsbanki and Glitnir) had assets equivalent to nine times GDP.

What’s it got to do with the financial crisis?

Iceland is an example of the worst-case scenario.

Iceland’s banks lent too much money compared to their customer deposits. As a result, they had to borrow money on the money markets to make ends meet. And when no one wanted to lend to them, they were in big trouble.

Understandably, Iceland tried to do something about the situation. The Icelandic government nationalised Glitnir in late September 2008. On 6 October, the government gave the country’s top financial regulator the right to run the troubled banks, including the right to force them to merge, or declare them bankrupt.

The regulator promptly suspended trading in the shares of Kaupthing, Landsbanki and Glitnir. It then nationalised Landsbanki and put it into receivership, before changing its mind about running Glitnir as a going concern, and putting that into receivership, too. By 8 October, only Kaupthing was left standing – thanks largely to a €500m loan from the Icelandic central bank and an emergency $702m loan to its Swedish operations from the Swedish central bank.

On 9 October, however, Kaupthing was nationalised, too. The Icelandic stock exchange was closed and trading in the Icelandic currency (by this time in free fall) was halted.

Iceland’s predicament is not global meltdown, but it shows what can happen to an individual country if its banking system fails. And that is:

• Plummeting currency: By the time trading in it was suspended on 9 October, the Icelandic krona had fallen 40% against the euro over the previous 12 months. It fell 14% against the euro between 29 September and 8 October 2008 alone, and was rated only marginally above the currencies of Zimbabwe and Turkmenistan.

• High inflation: As the local currency falls in value, it becomes more expensive to buy things from overseas. Hence inflation rises. In Iceland, inflation was running at 14% in October 2008 – more than four times the country’s target rate.

• Shortage of imported goods: If your currency plummets in value, it becomes more and more difficult to use it to buy things from other countries. Iceland is an import-dependent economy and will now struggle to buy everything from food to oil from elsewhere.

• Severe lack of cash: As the crisis worsened, Iceland’s association of pension funds transferred 200bn Icelandic krona (£1bn) to the state to help it prop up the banks.

• General panic: Queues formed at petrol stations as Icelanders rushed to fill up their tanks before fuel shortages kicked in. Savers tried to withdraw money from banks but found they couldn’t.

In October 2008, Iceland asked the IMF for a Return to A-Z home page