Iceland’s crisis ends happily ever after

No two crises are alike but Iceland’s was unusual in at least three ways. More so than any other crisis — Asian, Tequila, sub-prime — Iceland’s was predictable, profitable and purgative.

  • By Philip Moore
  • 10 Oct 2018
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It is easy to be wise after the event but Iceland’s crisis was so predictable it even had a dress rehearsal in 2006 when the so-called Geyser crisis sent Icelandic CDS prices soaring. Issuers and investors had also been given scores of warnings, principally about excess leverage, which they either ignored or ridiculed.

One of the most notable warnings was sounded by Danske Bank in March 2006. “On top of the macro boom, there has been a stunning expansion of debt, leverage and risk-taking that is almost without precedent anywhere in the world,” the bank warned. “External debt is now nearly 300% of GDP while short term external debt is just short of 55% of GDP. This is 133% of annual Icelandic export revenues.” The result, said Danske, was that the Icelandic economy had become “increasingly dependent on foreign capital and international terms of lending”. It added that “Iceland seems not only to be overheating but also looks very dependent on the willingness-to-lend of global financial markets. This raises the question of whether the economy is facing not just a recession but also a severe financial crisis.”

Nonsense, said Icelandic bank Glitnir, which argued in an angry rebuttal that Danske’s research had presented “a highly implausible forecast of a financial crisis” containing “numerous inaccuracies and errors, which... all serve to paint a bleaker picture than the facts would warrant.”

Danske’s was not an isolated voice. Fitch famously warned about the dangers lurking in Iceland when it changed its outlook from stable to negative in February 2006 and met with plenty of criticism for doing so. “We got into hot water for saying the Icelandic financial system looked like a hedge fund,” says Brian Coulton, head of EMEA sovereign ratings at the time and one of the co-authors of the Fitch note. “But to us it was all about the staggering expansion of the banks’ balance sheets in a very short period.”

Iceland’s banks responded to the events of 2006 not by reining in their ambitions and cutting back on their leverage but by exploring new avenues of borrowing — with calamitous results. As Jon Sigurgeirsson, director of general secretariat and international relations at the Central Bank of Iceland (CBI) puts it, Landsbanki bought its way out of the funding dilemma by offering depositors in the UK and the Netherlands some of the most generous rates available on internet savings accounts. Other banks, he says, bought their way out of the problem by paying unsustainably high spreads on their bonds, which were gobbled up by yield-hunting CDOs and European banks.


When the inevitable collapse came, with the three large banks tumbling like dominoes in the space of three days in October 2008, it was not just the Icelandic government’s grand (some say ridiculous) plans for establishing itself as a financial centre that lay in ruins. Socially, Iceland was torn apart by the events of late 2008, with many still expressing shock a decade later at the virtually unheard-of riots that disfigured Reykjavik at the height of the crisis. True, many of these were riots with a distinctly civilised, Icelandic flavour: on one occasion, a group of rioters outside the home of President Ólafur Ragnar Grímsson were reportedly invited in for coffee and a chat.

Nevertheless, although there were no fatalities during Iceland’s riots the disturbances following the crash opened up deep fissures in the country’s social fabric. One poll taken in October 2008 suggested that 32.5% of Icelanders were considering moving overseas. Among those aged 18 to 24, 50% were thinking of emigrating. When your population is a little over 300,000 losing that many people is socially and economically ruinous.

Yet Iceland’s recovery was remarkably swift. This was in part because the authorities — notably FME, the financial industry supervisor — responded with uncharacteristic decisiveness to Iceland’s predicament. Over the course of a weekend it had drafted an emergency law giving the regulator unprecedented powers to take control of the country’s banks and split them into two. The new banks, led by new management teams, would absorb domestic króna deposits and assets. That would leave the old banks (or estates) to manage the remaining liabilities and see what value their so-called resolution committees could squeeze out of their overseas assets.

The speed of the recovery was also a product of its containment within a single, bloated sector. “We always emphasise that Iceland’s crisis was not an economic crisis,” says Gudmundur Arnason, permanent secretary at the Ministry of Finance. “It was a banking crisis.”

That may be. But the real economy could not insulate itself entirely from contagion from the banking collapse, with growth contracting, inflation rising, unemployment ballooning and the debt ratio climbing from 27.3% pre-crisis to 95.1% by 2011. A number of key sectors, however, were entirely unscathed by the crisis and the sharp devaluation of the krona very quickly kicked in to buttress exports.

Then there was the sudden eruption of the Eyjafjallajökull volcano in 2010, which is described by one Reykjavik observer as having been the equivalent of a winning lottery ticket for Iceland’s tourism industry because it instantly put Iceland on the global map. According to research published by Landsbankinn, tourism alone contributed between 40% and 50% of Iceland’s 18.9% increase in GDP between 2010 to 2016, although it was clear long before 2016 that the economy had put the 2008 crisis behind it. “We’re now marking 10 years since the crisis, but five years ago it was clear that Iceland had turned the corner,” says Franek Rozwadowski, who became the IMF’s resident representative in Iceland in March 2009.


As for the banking sector, there had never been Northern Rock-style queues outside any of Iceland’s banks; nor would any have to close their doors to the public as they did in Cyprus in 2013. That, together with hard work and a more co-ordinated policy response, helped Iceland to build a new banking industry from scratch. “At the time we had no idea how big the challenge would be,” says Birna Einarsdottir, who took over as CEO of the new Islandsbanki in 2008. That is a post she still holds today making her the only CEO of a new bank to have served continuously since the crisis. “I’m not always this positive, but I think we handled the aftermath of the crisis very well.  The restructuring of our loan book was a huge challenge but it was something we managed in co-operation with our customers and with the support of a very fair and transparent framework from the government. I think overall the Icelandic people worked hard to get where we are today.”

Winning back friends in the international investor community was also a formidable challenge, as Einarsdottir recalls. She echoes the managers of the other new banks when she recounts the dispiriting experience of knocking on doors at the IMF meeting in Istanbul in 2009 and repeatedly finding them closed.

Against that backdrop it is remarkable that within three years Iceland had returned to the capital market, generating $2bn of demand for a $1bn five year benchmark bond issued in June 2011. Iceland’s re-entry into the capital market was all the more noteworthy given that the Icesave dispute was still unresolved at the time.

The banks were also back in the international capital market by 2015, a critical year that many regard as book-ending the crisis that had begun in October 2008. In June details were announced of a scheme that Sigmundur David Gunnlaugsson’s government had been devising for well over a year to ease the capital controls which were weighing on Iceland’s credit profile. Drawn up by a specially-created task force with advice from a number of international consultants, this allowed Iceland’s creditors (which by then were overwhelmingly hedge funds) to monetise their holdings in exchange for the payment of ‘stability contributions’ amounting to 17% of GDP.

On paper it hardly looked like an appealing option. But many of those funds had bought into the market at deeply distressed prices when the original creditors had jumped ship. This meant that most would be able to walk away from their Icelandic holdings with modest gains rather than spend years pursuing their claims through costly and messy litigation. For Iceland meanwhile, the so-called carrot and stick deal on capital controls meant that the Treasury had emerged from the seven year crisis with a profit, with the IMF estimating that the state made a net gain in excess of 9% of GDP.


Sigurgeirsson at the CBI thinks this may turn out to be an over-estimate, given that it is dependent on market values for the banks which today appear to be under the money. Nevertheless it is clear that Iceland has ended up profiting from its crisis. “A lot of people said that if we wrote off $6bn of debt we would be the new Argentina and never be able to borrow again,” says Bjarni Benediktsson, who was finance minister at the time of the stability contributions plan and is now in the post again. “But take a look at what has happened since. A big lesson of the crisis is that markets recognise the importance of low indebtedness and understood that we were never going to nationalise the private debt of the banks. What was lost was lost and life went on.”

Not all the gains that Iceland has extracted from its crisis are as quantifiable as those generated from the stability contributions. There is, however, general agreement that the Iceland that has emerged from the rubble of its financial crisis is a healthier and more cohesive society than it was immediately before the collapse of the banks.

The consensus is also that today’s economy is far more durable than the unbalanced structure that characterised it in 2007. “By all measures Iceland is better off than it was in 2007,” says Sigurdur Atli Jónsson, former CEO of Kvika Bank, who now runs a Reykjavik-based investment boutique, ILTA Investments. “The economy is more diversified, the savings rate is up and there is much less household and corporate debt in the system.”

That suggests that there was a purgative element to Iceland’s crisis, which is also reflected in the number of bankers who were prosecuted and jailed for their role in the crisis. That process, some believe, may have gone too far especially when former Prime Minister Geir Haarde was prosecuted (he was later exonerated) for failing to prevent the crisis. “It is one thing to prosecute people for wrongdoing,” says Rozwadowski. “It is quite another to bring politicians to trial for their policy performance.”

There may now be other crises bubbling under the surface in Iceland. Over-capacity in the tourism sector may be one especially if an ever-appreciating króna makes Iceland unaffordable. Another, as Finance Minister Benediktsson concedes, may be shadow banking, especially if regulation and taxation stifle the official banking sector.

For the time being, however, Iceland’s crisis has ended so happily for the country itself that conspiracy theorists and trashy novelists could almost be forgiven for wondering if it had all been meticulously stage managed.

  • By Philip Moore
  • 10 Oct 2018

All International Bonds

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1 JPMorgan 161,597.45 701 8.06%
2 Citi 158,100.45 638 7.89%
3 Bank of America Merrill Lynch 131,322.73 520 6.55%
4 Barclays 126,396.71 489 6.30%
5 HSBC 104,257.54 522 5.20%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 Bank of America Merrill Lynch 12,900.23 34 6.65%
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3 UniCredit 11,196.47 58 5.77%
4 Citi 9,580.75 37 4.94%
5 Deutsche Bank 8,953.95 35 4.62%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 Morgan Stanley 5,454.13 25 10.64%
2 JPMorgan 4,766.13 27 9.30%
3 Goldman Sachs 4,280.20 20 8.35%
4 Citi 3,649.88 23 7.12%
5 UBS 3,602.23 16 7.03%