Transcript Icelandic banks 2008 in context

Thorvaldur Gylfason

For decades, the government owned and operated
the banks
In 1930s, leaders of two main political parties sat side
by side on the board of Landsbanki, each representing
essentially bankrupt economic interests that went on to
divide the spoils (“Socialism of the Devil”)
 One of them sat there until the day he died in 1964,
despite serving as prime minister on five occasions
 Until late 1990s, bank directors and governing boards
were political players, with few exceptions
 With negative real interest rates and an overvalued
króna, bankers exercised significant power


Privatization 1998-2003 ought to have aimed to
sever those connections, but did not fully succeed

Two largest banks were sold in part to wellconnected individuals with close ties to the two
governing parties (“within calling distance”)

The two parties maintained their operatives on the
banks’ governing boards
Both banks were sold both at once at prices
deemed modest by the National Audit Office
 No serious attempt was made to attract foreign
buyers of banks as was done in the Baltics
 Unlike the Nordics and the Baltics, there is as
yet no foreign competition in Icelandic banking

More concentration of industry than among Nordics
 Large spreads between lending and deposit rates


Once freed from government control, the banks
kicked up their heels like cows in spring
Unprecedented borrowing and lending spree
 Borrowed short abroad at low interest to make long-term
housing loans at home at unprecedentedly low rates
 Some loans with variable interest rates after a five-year
grace period, to be renegotiated in 2009
 An element of sub-prime lending involved? Perhaps


Banks became international

Now derive half their earnings from foreign operations
 31 subsidiaries in 21 countries (October 2007)
 Net interest income: 50%-60% of total (2008, Q1-Q2)
 Net fee and commission income: 30%-40% of total
 High return on equity, capital adequacy 10%-11%
 Deposit/loans ratios 40%-60%, aim is to raise them

“A sound banker, alas, is not one who foresees
danger and avoids it, but one who, when he is
ruined, is ruined in a conventional way along
with his fellows, so that no one can really blame
him.” (J.M. Keynes).


Icelandic banks copied each other’s business model,
and possibly took on excessive risk
“Daring ideas are like chessmen moved forward.
They may be beaten, but they may start a
winning game.” (J.W. Goethe)

Icelandic banks faced an insignificant home market,
so their choice was essentially to “evolve or die”
Source: Union Bank of Switzerland, December 2007
Source: Union Bank of Switzerland.
10
9
8
7
6
5
4
3
2
1
0
Switzerland
Iceland
Net External Debt (% of GDP)
700
350
300
600
250
500
200
400
100
300
200
100
0
150
50
0
2004
2005
2007
2007
2008
International Investment Position (% of GDP)
0
-20
-40
-60
-80
-100
-120
-140
-160
-180
2004
2005
2007
2007
2008
% of short-term debt
140
120
100
80
60
40
20
0
Icelandic krónur (ISK)
0
20
40
60
80
100
120
140
160

Iceland has long been a high-exchange-rate place,
for several reasons






High inflation
Increasing foreign debts
Pervasive farm support, also for fisheries
High domestic prices of tradable goods (Big Mac index)
Recently, also, carry trade
How? Borrow in, say, yen at low interest, buy
krónur, place proceeds in high-interest accounts
Amount now outstanding, due within year: 20% of GDP
 Needs to be refinanced, not easy now
 Puts downward pressure on króna

Closer Look at 2004-2008 (% per year)
14
12
10
8
6
4
2
0
2004
2005
2007
2007
2008
 Stock
market rose by a factor of nine from
2001 to 2007

44% average annual increase six years in a row


World record
Clearly a bubble

Stock market has fallen by more than 50% since 2007
 Real
estate prices rose by a factor of 2.5
from 2001 to 2008


11% per year on average
Led to construction boom


Count the cranes! (Aliber)
Also, a bubble
 Three
largest banks (Kaupthing, Glitnir,
Landsbanki) saw their stock prices double,
and then fall back to square one, taking the
OMIX15 up and then back down with them

Banks account for 50% of OMIX15
 CDS
spreads for the banks have recently risen
to stratospheric heights (26 October 2008)



Glitnir: 1600
Kaupthing: 1500
Landsbanki: 1200

For comparison, Barclays: 200

Banks now face global credit crunch
No major currency mismatches or maturity mismatches
in their books as far as is known
 Capital inflows would have slowed down anyway,
reversing earlier appreciation of the króna
 Banks have protected themselves by indexing assets
and converting equity into foreign currencies


Credit crunch combined with deflation of twin
bubbles may result in significant write-offs



Lending sprees always do
Thus far, however, asset quality appears good
If a bank lands in big trouble, government would
need to renationalize it temporarily
Nordic solution, worked well in crisis of 1988-1993
 Bailout at taxpayer’s expense less attractive
