The Next Icelandic Banking Crisis

Includes: CRARY, RBS
by: Felix Salmon

How many times can Iceland’s banks fail? More than once, it would seem, in the wake of an important ruling by Iceland’s Supreme Court. It regards loans which were disbursed in Icelandic kronur but linked to either Swiss francs or the Japanese yen; the court has now ruled that the indexing is illegal, and that the borrowers need only to repay the loans at their initial interest rate in kronur.

The decision is popular in Iceland, as you might expect: these loans were in many cases the only ones available for big-ticket items like cars, and attempts to defend the banks tend to fall on deaf ears. Here’s Alda Sigmundsdottir:

It is interesting to me that these comments come pretty much exclusively from outside Iceland. I have not heard one single Icelander express this opinion. Personally, I strongly disagree with this view. I did not take out a currency basket loan and have not been subject to the same nightmare as those who did; however, not for a moment do I begrudge those people this ruling, even if it means I have to carry some of that cost indirectly and even though I still have my mortgage, which is indexed to the rate of inflation, and for which there appears to be no correction in sight, unlike that for the currency basket loans.

It’s important to note here that Iceland’s big three (new) banks are now owned by the creditors of the big three (old) banks, including RBS (NYSE:RBS), Credit Agricole (OTCPK:CRARY), and Deka. So the first-order effects of this judgment are that Icelandic citizens are the winners, while foreign banks are the losers. In the wake of a financial crisis like the one Iceland has just seen, it’s hard to argue with that kind of calculus.

Of course, it’s never exactly a good thing for a nation’s banks to become insolvent, although Iceland’s politicians don’t seem to be able to say even that these days. The result is something close to chaos. A correspondent in the Icelandic financial industry emails me:

The central bank governor has come under a lot of pressure after stating the blindingly obvious yesterday that if the foreign loans are “rewound” back to the original amount then the banks will be in big trouble. The minister of economic affairs (who is incidentally not a politician but a former econ/business professor) is allegedly under a lot of pressure as well and might be replaced after agreeing with the CB governor. Apparently they aren’t agreeing enough with the public who are somewhere between the “let the banks burn” department and the aisle of “everyone in charge hates the public”. At the same time people haven’t really given any thought to the fact that when the consumer protection agency was asked why it hadn’t looked into the possibility of illegality at the time of origination they claim that people weren’t complaining at the time, they were happy with these loans so nothing was done.

The latest move came this morning from the “Association of creditors” who advised people to withdraw their deposits from the banks before the CB governor and minister of banking’s predictions materialized. The connection between an association of people who took loans and people who have deposits hasn’t yet been explained. Among all the turbulence the one thing that you can predict with some conviction is that comments made by any lobby group, politician, or “public” figure is going to be both baffling and flawed. Looks like the road to recovery is going to be a long one.

It’s pretty irresponsible to advocate for a bank run — although since there are only really three banks in Iceland, it’s not obvious what depositors are supposed to do with their money after they’ve withdrawn it. Buy lots of smoked fish and store it in the garden shed, perhaps?

What’s abundantly clear is that Iceland’s banks have failed it to the point at which they have lost the trust of the public — and that the government, including the judiciary, is doing a good job of representing the will of the people. Given that state of affairs, which seems unlikely to change, the problems facing the Icelandic economy are even greater than many think: it’s hard for economies to grow when they have a dysfunctional banking system lacking basic trust in institutions. Especially when no one seems to be expending any effort on finding a solution to that problem.