Transcript Slide 1

Central Bank of Iceland
The financial crisis in Iceland
Causes, consequences, policy responses and recovery
Már Gudmundsson
Central Bank of Iceland
Adam Smith Seminars, Paris
November 10, 2009
Prologue
The financial crisis in Iceland
The major banks collapsed following Lehman’s fall …
The financial crisis in Iceland
… as FX funding dried up and a run on the banks’
short-term liabilities escalated swiftly
The financial crisis in Iceland
… in a situation where limited capacity existed to
replace private FX funding with public lending
BALANCE SHEET OVERVIEW IN
SEPTEMBER 2008
COMMERCIAL BANKS
NON-FINANCIAL PRIVATE
SECTOR
Assets
Liabilities
500% of GDP
REST OF THE WORLD
Liabilities
Assets
919% of GDP
Liabilities
Assets
658% of GDP
PUBLIC SECTOR
Liabilities
Assets
The chart above gives a simplified summary of the balance sheets of
the non-financial private sector , financial institutions, the public
sector, and non-residents, illustrating total assets and liabilities for
each sector as of September 2008.
International comparison
The largest banking system to go through a crisis …
Consolidated banking group assets relative
to GDP by nationality of ownership at year
end 2007
Commercial banks' assets in percent of
GDP a year before the onset of a crisis
Percentage of annual GDP
Percentage of annual GDP
900
1000
800
900
800
700
700
600
600
500
500
400
400
300
Sources: Bank of England, Central Bank of Iceland.
Iceland
US
Italy
Canada
Australia
Japan
Spain
Germany
France
Ireland
UK
Iceland ('08)
Japan ('91)
Venezuela ('94)
Turkey ('00)
Thailand ('97)
Sweden ('91)
Russia ('98)
Norway ('87)
Mexico ('94)
Malaysia ('97)
Korea ('97)
0
Indonesia ('97)
0
Finland ('91)
100
Equador ('98)
100
Chile ('81)
200
Switzerland
300
200
1. Total consolidated banking group assets fro domestically owned
banking sector only. This includes assets of domestic banks held
abroad. End-2007 except UK (end 2008) and Iceland (June 2008).
Sources: Bank of England, Central Bank of Iceland.
International comparison
…with the most indebted private sector …
International comparison
…and widespread foreign-currency borrowing
Corporate foreign currency debt
to GDP in a few crisis countries
350
%
300
250
200
150
100
Sources: IMF, Central Bank of Iceland.
Iceland ('08)
Uruguay ('01)
Brazil ('01)
Korea ('96)
Thailand ('96)
0
Argentina ('00)
50
Two partly independent stories
Iceland’s domestic boom-and-bust cycle …
Two partly independent stories
… and the rise and fall of Iceland’s cross-border banks
Ban k o f En g lan d liq u id it y in d ex an d t o t al
asset s o f t h e t h r ee m ajo r b an ks Q1/ 2001Q3/ 2008
In d ex
% o f GDP
1,0
700
0,8
600
0,6
500
0,4
0,2
400
0,0
300
-0,2
-0,4
200
-0,6
100
-0,8
-1,0
0
2001
2002
2003
2004
2005
2006
2007
2008
Ban k o f En g lan d f in an cial m ar ket liq u id it y in d ex (lef t )
Asset s as p er cen t o f GDP (r ig h t )
So u r ces: Ban k o f En g lan d , Cen t r al Ban k o f Icelan d
Large macroeconomic repercussions
Reflected in a large drop in the exchange rate
Large macroeconomic repercussions
Asset destruction
St o ck p r ice r ises an d su b seq u en t
f alls in Icelan d an d o t h er ad van ced
eco n o m ies
Ch an g e in r eal h o u se p r ices (Q1/ 2001-Q3/ 2006)
Ch an g e in r eal st o ck p r ices (Q1/ 2001-Q3/ 2006)
Real h o u se p r ices f alls f r o m r ecen t p eak
Real st o ck p r ices f alls f r o m r ecen t p eak
So u r ces: IMF, Cen t r al Ban k o f Icelan d
So u r ces: IMF, Cen t r al Ban k o f Icelan d
Icelan d
Sp ain
New Zealan d
Ir elan d
Fr an ce
UK
Den m ar k
Sw ed en
Can ad a
USA
Icelan d
Sp ain
New Zealan d
-200
Ir elan d
-40
Fr an ce
-100
UK
-20
Den m ar k
0
Sw ed en
0
Can ad a
100
Au st r alia
20
Fin lan d
200
No r w ay
40
It aly
300
USA
60
%
Au st r alia
400
Fin lan d
%
No r w ay
80
It aly
Ho u se p r ice r ises an d su b seq u en t
f alls in Icelan d an d o t h er ad van ced
eco n o m ies
Large macroeconomic repercussions
Challenging government debt situation
Large macroeconomic repercussions
Drop in output
Eco n o m ic g r o w t h p r eceed in g an d f o llo w in g
cr ises in a n u m b er o f co u n t r ies
Fo r ecast f o r GDP g r o w t h in 2009
Med ian (lin e), d ist r ib u t io n s (b o xes) an d a f o r ecast f o r
Icelan d (b r o ken lin e)
Vo lu m e ch an g e o n a year ear lier (%)
Vo lu m e ch an g e o n a year ear lier
15,0
(1991), In d o n esia (1998), Ko r ea (1998), Malaysia (1998), Mexico (1995),
Ph ilip p in es (1998), Ru ssia (1998), Th ailan d (1998), Tu r key (2001), Ur u g u ay
(2002).
So u r ces: IMF, Cen t r al Ban k o f Icelan d .
So u r ce: IMF Wo r ld Eco n o m ic Ou t lo o k Oct o b er 2009
New
No r w ay
Sp ain
t +4
Den m ar k
t +3
Net h er lan d s
t +2
Un it ed
t +1
Eu r o ar ea
t
Sw ed en
t -1
Jap an
t -2
Ger m an y
t -3
Fin lan d
t -4
1. Ar g en t in a (2002), Br azil (1999), Bu lg ar ia (1996), Ecu ad o r (1999), Fin lan d
Hu n g ar y
-15,0
Ir elan d
-10,0
Icelan d
-5,0
Ro m an ia
0,0
Lat via
5,0
Est o n ia
10,0
Lit h u an ia
0,0
-2,0
-4,0
-6,0
-8,0
-10,0
-12,0
-14,0
-16,0
-18,0
-20,0
Large macroeconomic repercussions
Rise in unemployment and high inflation
Un em p lo ym en t af t er b an kin g cr ises
Fir st q u ar t er is t aken t o b e p eak o u t p u t g ap p r io r
t o t he dow nt urn
20
18
16
14
12
10
8
6
4
2
0
% o f lab o u r f o r ce
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
Qu ar t er s
Icelan d Q1/ 2008-Q4/ 2012
Sw ed en Q4/ 1989-Q3/ 1998
Fin lan d Q3/ 1989-Q2/ 1998
No r w ay Q2/ 1986-Q1/ 1995
Un it ed St at es Q1/ 1990-Q4/ 1998
1. Cen t r al Ban k o f Icelan d b aselin e f o r ecast Q1/ 2009-Q4/ 2012.
So u r ces: Dir ect o r at e o f Lab o u r , Reu t er s Eco w in , Cen t r al Ban k o f
Icelan d .
•
The build-up
Build-up of domestic imbalances
Started as a positive FDI shock
Build-up of domestic imbalances
Credit boom following privatisation and restructuring
Build-up of domestic imbalances
Fuelling asset price bubbles
Build-up of domestic imbalances
Wide interest rate differential encouraged carry trade
Build-up of domestic imbalances
Iceland’s economy was vulnerable to the global crisis
Expansion of the cross-border banks
Privatisation, consolidation and expansion …
Expansion of the cross-border banks
… extremely rapid expansion
Relatively big and geographically dispersed
•
•
•
•
Total assets around 200 b.$
11 times Iceland’s GDP before the collapse
41% of total assets in foreign subsidiaries
60% of total lending to non-residents and
60% of income from foreign sources
• Over 2/3 of total lending in terms of foreign
currency
• Around 2/3 of deposits in foreign currency
Expansion of the cross-border banks
The EEA framework
• Iceland became a member of the EEA in 1994
• Free movement of capital
• European “passport” for financial institutions
headquartered in any country within the area
• Common legal and regulatory framework …
• … but the safety net (eg deposit insurance and LOLR)
and crisis management and resolution remained largely
national
• There was a inbuilt vulnerability/risk in this setup,
especially for small countries outside the euro area
The crisis
The crisis
Distrust in Icelandic banks and their lack of FX funding
led to the break down of the main channel for inflows …
The crisis
… causing a large depreciation of the currency and
rapidly increasing inflation
Mynd 4
Chart 1
FX swap-implied ISK rates minus EUR Libor
and the Icelandic króna
Daily data, August 2007 - May 2008
%
EURISK
12
82
10
90
8
98
6
106
4
114
2
0
122
-2
130
ágú.07 sep.07 okt.07 nóv.07 jan.08 feb.08 mar.08 maí.08
1-month interest rate diffential (left)
3-month interest rate diffential (left)
EURISK, reversed (right)
Sources: Bloomberg, Central Bank of Iceland.
The crisis
Private consumption lost momentum as real wages,
confidence and credit all contracted
The crisis
As the global crisis deepened and reached its climax
•
•
•
•
7/9 2008: Fannie Mae and Freddie Mack taken into conservatorship
15/9 2008: Lehman Brothers files for Chapter 11 bankruptcy
16/9 2008: A large US money market “breaks the buck”, support given to AIG
18/9 2008: Coordinated central bank measures to address US dollar funding
squeeze, the other Nordic CB participated but not the Central Bank of Iceland
• 25/9 2008: Glitnir asks for FX emergency loan
The crisis
… the Icelandic banks’ collapse
• 29/9 2008: Glitnir takeover announced (€600 million), bank
failures in Europe and US, and US House of Representative
rejects TARP
• 30/9 2008: Sovereign and bank downgrading followed by
widespread margin calls and closing of credit lines – domestic
domino effects. In Ireland a wide-reaching guarantee is given to
bank debt
• 6/10 2008: Emergency laws in Iceland
• 7/10 2008: Glitnir and Landsbanki intervened by FME
• 8/10 2008: Freezing of Icelandic assets in the UK and takeover of
Kaupthing’s Singer &Friedlander
• 8/10 2008: System-wide responses by central banks and
governments, increased international coordination
• 9/10 2008: Kaupthing intervened by FME
Expansion of the cross-border banks
Some key metrics as of June 30, 2008
Kaupthing
Landsbanki
Glitnir
11.2%
10.3%
11.2%
Tier 1 ratio
9.3%
8.2%
8.0%
Leverage ratio
15.1
20.0
19.3
Equity/tangible assets
5.2%
4.0%
3.6%
5y
5y
3.2y
32.3%
72.4%
20.8%
1.95
1.74
1.52
CAD ratio
Bond maturity
Deposits/funding
Liquidity ratio
Why did the banks then fail?
•
•
•
Big foreign currency
balance sheets with a
significant maturity
mismatch but
without a lender-oflast resort (LOLR)
Size relative to the
home base (country
and currency)
Fatal flaws in the EU
financial architecture
Triggers and contributing factors:
 The international financial crisis
 Flaws in business models and risk
management
 Iceland’s big macroeconomic imbalances
 Domino vulnerabilities in Iceland’s financial
sector (eg cross-ownership, connected
lending, large exposures across institutions)
 Bad governance and accounting?
 Non-cooperative crisis management across
interested jurisdictions
The crisis
Systemic European event
• Event of systemic proportions in parts of Europe
• Failure of private and public risk management policies in
Iceland
• Failure of the EU framework for cross-border banking
• Figures as an example in major reports
• Will affect the shape of a future framework for the
regulation and supervision of cross-border banks
• Also a key example of the problems with cross-currency
liquidity management during the crisis - lack of CB
liquidity provision and ELA facilities in terms of foreign
currency
The crisis
The banks’ collapse deepened the economic
recession that was already in the charts
Fo r ecast s f o r p r ivat e co n su m p t io n
grow t h
Fo r ecast s f o r r eal h o u se p r ices
Co m p ar iso n b et w een Cen t r al Ban k f o r ecast s
b ef o r e t h e b an ks' co llap se an d t h e lat est
f o r ecast
Co m p ar iso n b et w een Cen t r al Ban k f o r ecast s
b ef o r e t h e b an ks' co llap se an d t h e lat est
f o r ecast
%
Vo lu m e ch an g e o n a year ear lier (%)
0
0
-2
-5
-4
-6
-10
-8
-15
-10
-12
-20
-14
-25
-16
-30
-18
2008
2009
2010
Aver ag e f o r ecast f o r p r ivat e co n su m p t io n g r o w t h
b ef o r e t h e b an ks' co llap se
Pr ivat co n su m p t io n g r o w t h in t h e No vem b er 2009
f o r ecast
So u r ces: St at ist ics Icelan d , Cen t r al Ban k o f Icelan d .
2008
2009
2010
Aver ag e f o r ecast f o r r eal h o u se p r ices g r o w t h b ef o r e
t h e b an ks' co llap se
Real h o u se p r ices g r o w t h in t h e No vem b er 2009
f o r ecast
So u r ces: St at ist ics Icelan d , Cen t r al Ban k o f Icelan d .
The policy responses
The policy responses
IMF program
•
•
•
•
A two year Stand-by Arrangement was initiated in
November 2008
External financing from IMF, the Nordic countries,
Poland and others
Extensive technical assistance
First revision delayed but was completed in
October 2009
The policy responses
Key features of the IMF program
1. Exchange rate stability
– Monetary policy’s
contribution is to protect
vulnerable balance sheets
while their restructuring
takes place
– Unconventional
measures: capital
controls and FX
interventions
– FX reserves build-up
Monetary stance has been relaxed but
still too tight for the domestic economy
The policy responses
Key features of the IMF program
2. Bank resurrection and
debt restructuring
–
–
–
Approximately 90% of
the banking system
collapsed, markets
seized up and private
sector debt and payment
problems increased
Bank restructuring has
been delayed but
important milestones
have been reached
The conditions ripe for
private sector debt
restructuring
The policy responses
Key features of the IMF program
3. Public debt
sustainability
–
–
–
Debt sustainability
analysis
Plan for government
finances and
decisive action on
that front
Multilateral and
bilateral loans
Exchange rate developments
The ISK remains weak but has stabilised…
Exchange rate developments
… despite declining interventions by the Central Bank
The prospects for recovery
The prospects for recovery
The contraction seems to be bottoming out
The prospects for recovery
The economy’s flexibility has provided support
The prospects for recovery
The economy’s flexibility has provided support
An underlying current account deficit is
turning into a surplus
The economy will begin to recover in the
beginning of next year
Longer term prospects
• Iceland´s longer term prospects are
underpinned by the strong resource base and
human capital
• The degree and mode of integration with the
rest of the world is also under consideration
• There are probably more than one or two
alternatives
• Iceland has now applied for EU membership