Iceland’s Financial Crisis & a Look at the Country’s Record-Fast Recovery
GUEST SPEAKER PRESENTATION | 09:10 – 10:00
Speaker:Bjarni Benediktsson, Minister of Finance and Economics, Icelandic Ministry of Finance and Economic Affairs
The Road to Recovery
May 2019
The Boom
The long-term economic
prospects for the
Icelandic economy
remain enviable.
- IMF Article IV statement
in July 2008
Excessive imbalances prior to crisisInternational search for yield and passporting within the EEA challenging
Source: Central Bank of Iceland
0%
250%
500%
750%
1000%
2003 2004 2005 2006 2007
Total Assets of Three Largest Banks% of GDP
-25%
-20%
-15%
-10%
-5%
0%
5%
2001 2002 2003 2004 2005 2006 2007 2008
Current account balance% of GDP
Source: Central Bank of Iceland
One of the largest bankruptcies in the worldWith FX liabilities 70% of the banks’ balance sheets
691
328
182
104 91 83 80 66 61 50 49
CIT Group ConsecoWorldCom GlitnirBank
EnronGeneral Motors
LandsbankiÍslands
Lehman KaupthingBank
WashingtonMutual
The three Icelandic
banks, total
1035% 472% 284% 279%Share of GDP
Comparison with US corporate history
A currency and economic crisisSharp depreciation of the ISK and a sudden stop in capital flows and growth
Source: Central Bank of Iceland and Statistics Iceland
60.
70.
80.
90.
100.
110.
-5 -4 -3 -2 -1 0 +1 +2 +3 +4 +5 +6 +7 +8 +9 +10
EA-5 (1996)SEA-5 (2006)Iceland (2007)Finland&Sweden (1991)
Real Effective Exchange Rate (Index, pre-crisis year =100)
18.0
%
14.8
%
7.8%
7.5%
6.8%
4.9%
4.9%
4.2%
3.6%
2.0%
0%
5%
10%
15%
20%
Latv
ia
Lith
uani
a
Finl
and
Irela
nd
Icel
and
Denm
ark
Uni
ted
King
dom
EU (2
7co
untr
ies)
Spai
n
Gree
ce
Contraction of GDP 2009
Source: IMF, World Economic Outlook
The Reaction
In August 2008, a Harvard Business School case asked: what if anything should Iceland to do avoid future crisis.
The case stated: In May 2008, a team at Moody's had to decide whether to downgrade the country’s rating from Aaa to Aa1 or lower. Investor sentiment toward Iceland had changed radically in March, and the team was fearful that the situation could spiral out of control. The team knew that carry traders increased Iceland's vulnerability to a confidence crisis because they were quick to liquidate their holdings at the first sign of distress.
The plunge in the Icelandic Krona since the beginning of 2008 also forced the Icelandic people to confront a decision: would joining the European Union (EU) protect Iceland from capricious swings in investor sentiment?
Alarm bells had already been sounded
A balanced economic programme
Programme focused on:
1. Exchange rate and monetary
stability.
2. Rebuilding fiscal position.
3. Restructuring a functioning
financial sector.
• An economic programme was
developed with the IMF and
funded by the Fund (USD 2 bn),
the Nordic countries (including
the Faroes) and Poland (EUR 2bn).
– To strengthen reserves
Too big to fail or too big to save?
• ‘The Emergency Act’ - A bail-in
banking regulation developed and
implemented
– Banking system allowed to fail
– Domestic assets, liabilities and
operations of the failed banks
transferred into new Icelandic-
centric banks
• Icelandic taxpayers should not have
to shoulder excessive private sector
losses
• Burden put on the industry’s
uninsured creditors rather than
taxpayers.
Banking system for a domestic market
0
200
400
600
800
1,000
1,200
2008 2017
% of GDP
Source: European Central Bank
2008: 2.644%2017:1486%
And impose capital controls
• The exchange rate stabilized shortly after restrictions were imposed and helped in revitalizing the economy
– Created fiscal space
– Allowed for the easing of monetary policy
– Provided breathing space to restructure and resolve impaired balance sheets across the economy (banks, corporates, households etc.)
• Stabilizing the exchange rate was
imperative to stem highly adverse
balance-sheet effects
– Two-thirds of local corporate debt
foreign currency-linked and
extensive indexation of household
debt
A “short term” tool that lasted nearly a decade
The overhang issue was complexRequiring a sequenced approach with clear incentives
Pension funds
Individuals
Icelandic firms
Failed banks’ estates
The Capital Controls
Offshore ISK owners
Iceland
UK
Malaysia
Overhangs as a share of GDP: historical comparison
% OF GDP
112%
• Five groups wanted to transfer capital out of Iceland
creating an balance of payments (BOP) overhang
• As the dust settled it became evident that this BOP
overhang was unprecedented in global and historical
context
The IMF estimated in March 2015 that
the short-term capital outflow could
total up to 70% of GDP if no
countervailing action were taken
Guiding principles for removal of capital controlsLimit risk, preserve stability and avoid socialization of private debt
1. To resolve balance of payments problem in a manner that allows for a comprehensive lifting of controls without undue risk to macroeconomic and financial stability
2. Solutions that preserve social and economy stability and long-run sustainability
3. Limit risk to the government’s finances and avoid socialization of private debt or risk
4. Promote external market access for banks and major firms
5. Honor international responsibilities on equal treatment under the Icelandic Constitution
6. Preference for measures offering simplicity over complexity, minimize legal risk and a timely ending to the process (finality)
7. Public disclosure and transparency
The liberalization planVoluntary measures and sequenced lifting of controls
• Claimants of the estates of the three largest failed banks proposed voluntary packages of measures to
comply with the stability conditions in June 2015
– Domestic assets, including equity in Íslandsbanki, one of the three new banks, handed over to the
authorities, leading to exemptions from controls (around USD 3.5 bn).
• Auctions held for offshore ISK holders where locked-in investors could bid for FX and leave the capital
controls. Early departure at a discount.
• Capital controls on domestic entities lifted in March 2017.
• Remaining blocked accounts opened in March 2019. Limited rush to the door with new inflows largely
balancing out outflows.
“One is really just speechless over it all”
– Lee Bucheit on the liberalization plan in 2015
No FX instability or legal risks following the implementation of the liberalization plan
Fiscal sustainability sought at same time
5%
-13%
-10% -10%
-5%-4%
-2%0% -1%
12%
1% 1%
-15%
-10%
-5%
0%
5%
10%
15%
0%
10%
20%
30%
40%
50%
60%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
General Government accounts
Financial balance, r.ax Revenue Expenditure
% of GDP
Source: Statistics Iceland
1.2% without stability contrib.
Iceland has recovered direct cost of crisis
0%
20%
40%
60%
80%
100%
Indo
nesia
199
7
Thai
land
199
7
Turk
ey 2
000
Kore
a 19
97
Mex
ico
1994
Chile
198
1
Finl
and
1991
Braz
il 19
94
Japa
n 19
97
Mal
aysia
199
7
Lith
uani
a 19
95
Boliv
ia 1
994
Esto
nia
1992
Nor
way
199
1
Swed
en 1
991
Icel
and
2008
Recovery rate for governments of direct fiscal costs of financial crisis
Leading to a much improved debt position
0%
10%
20%
30%
40%
50%
60%
70%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
% GDP
Source: Ministry of Finance and Economic Affairs
Fiscal Strategy Plan
Our cheat sheet for the Harvard case:
• Let private investors shoulder own risks.
• Impose capital controls if needed and remove them only gradually.
• Act in a decisive but measured manner to minimize legal risks.
• Downsize banks to serve the domestic sector.
• Rebuild private sector balance sheets and unload failed companies from bank balance sheets
• Allow exchange rate to reflect economic fundamentals.
The Recovery
Increased savings have transformed economy
-2%
0%
2%
4%
6%
8%
-70%
-20%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
External balance has improved
International Investment Position
Current Account Balance, r.ax
0%50%
100%150%200%250%300%350%400%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Debt levels have fallen
Households Corporate General Government
% of GDP
Source: Central Bank of Iceland Source: Statistics Iceland
A major structural change that further improves resilience.
Diversification of economy with growth of tourism
0
0.5
1
1.5
2
2.5
Foreign tourists in Iceland (million)
Source: Icelandic Tourist BoardSource: Statistics Iceland
0%
2%
4%
6%
8%
10%
12%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Share of selected industries in GDP
Fishing and fish processing Tourism
The share of tourism in export earnings has risen from 26% in 2013 to 39%
With Pension funds playing an important role
9 12 16 21 25 30 27 25 23
0
50
100
150
2010 2011 2012 2013 2014 2015 2016 2017 2018
Pension funds assets, % of GDP
Other assets Loans to pension fund membersDomestic equities, mutual funds, and Enterprise Investment Fund DepositsOther bonds and bills Housing Bonds, Housing Authority Bonds, HFF bondsPublic sector Foreign assets
Funds have become large players in domestic equity and direct mortgage lending
Source: Central Bank of Iceland
Fast and Strong Recovery
Source: OECD, May 2019
-10
-8
-6
-4
-2
0
2
4
6
8
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
GDP growth, % YOY
Norway Portugal Greece Germany UK Iceland
%
With relatively strong long-term projections
Source: OECD
AustraliaCanada
DenmarkFinlandGermany
IcelandIreland
Italy
Japan
NetherlandsNorwaySpain UK
USAIsrael
0
5
10
15
20
25
30
35
40
45
50
0 20 40 60 80 100 120 140 160 180 200
Old
age
dep
ence
y ra
tio
Assets of pension funds, % of GDP
Assets of pension funds and old age dependency ratio
Lessons for the future:• Build buffers for rainy days – imperative to be able to react to crisis
• Preserve a flexible and outward oriented economy – but be self sufficient
• Make sure private investors bear the cost of own risk.
• Don’t fear threats of future lock-out of capital markets if measures are fair and work towards long-term sustainability.
• Preserve flexibility of exchange rate and monetary policy.
• Strong mico- and macro-prudential oversight.
