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Coping with a Banking Crisis – Rise, Fall and Rebirth of the Icelandic Banking System

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Coping with a banking crisis – Rise, fall and rebirth of the Icelandic banking system Second International Workshop on Managing Financial Instability in Capitalist Economies Reykjavik, Iceland September 23 - 25, 2010 Tryggvi Pálsson, Director Financial Stability Central Bank of Iceland SI-65698 Coping with a banking crisis The Rise 2 Iceland • In the 20th century Iceland went from being one of the poorest economies in Europe to a prosperous one – High but volatile growth, -mostly led by fisheries – From 2/3 of labour force in agriculture to 2/3 in services • In past decades: liberalization, deregulation and privatization • 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, e.g. deposit insurance and LOLR, and crisis management and resolution remained largely national (a poisonous coctail) 3 Banking system: - from sectoral and state owned to fully privatized (2003) - major acquisitions abroad 2004-2005 4 Kaupthing Bank Kaupthing began operations in Faroe Islands Stockholm branch opened Kaupthing Bank A new investment bank, New York office Commenced merged wtih Kaupthing Denmark, opens in was opened operations in London Bunadarbanki Islands Copenhagen Organic 2001 2002 2003 2004 2005 2006 2007 2008 Acquired the Stenghthens its Buy a 20% share in the Indian Finnish securities Norwegian operation by Acquired the British bank financial firm FiNoble Advisors Kaupthing acquired Acquired JP company Sofi, now acquiring the securities Singer & Friedlander Privat. Kaupthing has a option Handsal Asset Nordiska Bank in Kaupthing Bank Oyj firm A.Sundvall to buy the remaining shares in Management, based Sweden in Geneva five years time Acquired Acquired the The newly merged KB Bank Kaupthing dobbles Kaupthing Bank Kaupthing acquired a Swedish securities acquired the Norwegian in size with the Luxembourg acquired 20% share in firm Aragon asset manegment firm, acqusistion of the PFA Pension Fund Norwegain insurence Tyren Holding. Acquired the Danish bank FIH (LUX) Finnish insurance company company Storebrand Novestia Oyj as well Acquired BMY Corporate Fiinance (UK), now Kaupthing Limited ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 Total Assets 5 Glitnir Bank Glitnir Property Group established in Olso Office opened in Shanghai Islandsbanki and FBA Office opened in Branch opened in Office opened in Office opened in Office opened in merge London Luxembourg Copenhagen Halifax New York Organic 2001 2002 2003 2004 2005 2006 2007 2008 Acquried Swedish Acquired Finnish FBA acquired one of Acquired the securities firm Fisher 2000Britains oldest banks Partners securities 2008 Norwegain bank company FIM R.Raphael & Sons BNbank Acquired the Acquried Swedish real estate Acquired the Norwegian financial advisor Leimdörfer into Norwegain bank firm FactoNor, by Acquired Glitnir Property Group KredittBanken KredittBanken Enter the Norwegian securities market with the acqusition of Norse securities ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 Total Assets 6 Landsbanki Merger with part of Burdaras Privatisation London branch Amsterdam branch complete established opened Organic 2001 2002 2003 2004 2005 2006 2007 2008 2000 Acquisition of Acquired Acquisition of Bunadarbanki Acquisition of UK Acquisition of UK 2008 70% share in remaining shares International, now deposit bank investment bank Heritable Bank in Heritable Bank Landsbanki Luxembourg Cheshire Guernsey Bridgewell plc. Acquisition of three Europian (UK) Acquisition of UK securities companies: financial service Teather & Greenwood (UK), firm Key Finance, Kepler Equities (France) and Acquired by Heritable Bank Merrion Capital (Ireland) ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 Total Assets 7 Rapid expansion of the banking system • Assets 2 times GDP in 2003, roughly 11 times Total assets of banking system/GDP 18.000 12,00 GDP in 2008 16.000 10,00 14.000 • Two thirds of the banks’ 12.000 8,00 10.000 activities were in other 6,00 b.ISK 8.000 countries and more than 6.000 4,00 4.000 half of their revenues 2,00 2.000 0 0,00 • No foreign banks were 2003 2004 2005 2006 2007 2008 Year operating in Iceland Nominal GDP Total assets of banking system* Assets/GDP 7 Rapid expansion of the banking system • Macro imbalances domestically – Large aluminium investment projects – Housing loans by banks: initiated in 2004 and not properly funded – Decrease of direct and indirect taxes – Balance of payments showing increasing deficits • Business opportunities were tempting – Easy access to market financing with low rates and risk premia – Appreciating currency partly due to carry trade (Glacier bonds) – Acquisitions of financial companies in other countries and establishment of branches easy due to EEA agreement – Icelandic banks were highly rated by credit rating agencies • For a while in 2007 the banks had the highest possible rating with one of the rating agencies 9 Mini crisis 2006 • Foreign investors & media expressed concern – Too rapid expansion and risk appertite – Reliance on market funding – Ownership structure and governance “Iceland provides global warning to Wall Street” Wall Street Journal: Apr. 10, 2006 10 The crisis of confidence (in 2006) - as seen by investors* Even though profitable, the growth Growing borrowings, with over- was too dramatic! reliance on wholesale funding It all appears unreal to the Perceived vulnerability of banks with average Small and little understood economy… deteriorating macroeconomic investor! with absolute and relative macroeconomic environment indicators out of sync with Western Europe Limited understanding of the Frequent and transformational ownership structures with intricate acquisitions, with young management cross-shareholdings teams One-way bets by big money managers followed by negative analyst reports become a self- fulfilling prophecy to blow out spreads and shut market! * Sandeep Agarwal, MD, Head of FIG Debt Capital Markets, Credit Suisse 11 Market financing peaked in 2005 New Debt Issues from Icelandic Banks 16 EUR STG USD Other 14 12 10 8 6 4 Source: Bondware,2 20 April 2007 Note: Including Icelandic Banks (€bn) by Issuance FIH for Kaupthing 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 YTD European Medium Term Notes dominant until 2006 when US issues replaced EMTN 12 Maturity profile just before the downfall 13 Contingency work in run-up to crisis • Contingency working group established in 2006 – Representatives from three ministries, the Central Bank and FME (the Icelandic FSA) – Ever increasing frequency of meetings as of late 2007 • Contingency exercises – Payment systems exercise in 2007 – Nordic/Baltic crisis management exercise in September 2007 • Among Central Bank measures – Internal contingency group activated in Nov. 2007 – Closer cooperation with FME – Intensified liquidity monitoring both in frequency and coverage – Advise sought from international experts – Relayed concerns to the government – Pressured banks to downsize and encouraged subsidiarisation of banks’ operations abroad – Swap arrangements with three Nordic central banks 14 Coping with a banking crisis The Downfall 15 Crisis Timeline October 6th •Trading in three largest February 9th Icelandic banks suspended October 7th November 19th •Governor IF resigns from •CBI grants Kaupthing 500 •Emergency banking bill •IMF programme the CBI m. EUR liquidity support passed signed • Government guarantees all •FME (Icelandic FSA) takes February 27th deposits control of Landsbanki November 21st •New laws passed on the •Prime minister announces •FME takes control of Glitnir •S&P downgrades Central Bank. New governor that the country is in danger •Glitnir is downgraded Iceland to BBB- and deputy governor of “national bankruptcy” •Trading on the FX market is appointed ground to a halt September November 28th March 9th 15th •The Central Bank •FME takes control of •Collapse of activates capital Straumur Lehman controls October 8th •Landsbanki assets frosen February 26th to March •Moodys downgrades January 25th 13th •Minister of Business affairs September 29th Iceland •IMF mission to Iceland resigns •Icelandic State •Riksbanken grants •Director of the FME and the announces its Kaupthing 520 m. EUR board suspended plans to inject liquidity line capital into Glitnir March 21st •S&P downgrades October 9th February 1st •FME takes control Iceland •FME takes control of •Previous government of SPRON and Kaupthing replaced by a minority Sparisjóðabankinn •Trading of all stocks on the government (Icebank) stock exchange is suspended •Fitch downgrades Iceland 16 Collapse of 88% of the banking system • In early October 2008 the major banks Glitnir, Landsbanki Íslands and Kaupthing, representing 88% of the banking system in asset terms, collapsed in a week. (In March 2009 a second wave increased it to 97%) • Large defaults internationally; a devastating blow for a small economy 17 Comparison with previous crises •Relatively largest banking system ever to have gone through a crisis and an unusually large share of it became insolvent Commercial banks' assets in Share of banking system in insolvency various previous financial crises in various previous crises % of GDP % of total banking system assets 1000 100 900 800 80 700 600 60 500 400 40 300 200 20 100 0 0 Chile ('81)Chile Korea ('97) Japan ('91) - Russia ('98) Turkey ('00) Mexico ('94) Iceland ('08) Finland ('91)Finland Chile ('81)Chile Norway ('87) Norway Sweden ('91) Sweden Spain ('77)Spain Equador ('98) Thailand ('97) Malaysia ('97) Malaysia
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