EuropeanOct 23 2015

Iceland: You win some, you learn some

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Iceland: You win some, you learn some
ByJulia Faurschou

Nothing creates panic like telling people they cannot access their money, and despite all three major Icelandic banks failing in less than a week, none of them immediately closed their business. Instead, capital controls were put in place to limit outflows of cash from Iceland. Not only did this prevent the banks from immediately losing all liquidity, but acted as a happy medium between the two extremes of full capital flight and complete shut down. Overhanging debts were also written down, helping bring the stagnant economy back to life.

Limits were also put on the ability for bank deposits to be converted into hard currency. When each bank failed, a new bank took its place. This was done by moving all critical assets and liabilities into the new, better capitalised bank, but in the process ensured that more assets than liabilities made the transfer.

Jon Steinsson, who was an adviser to the prime minister of Iceland in 2008 and is currently an associate professor of economics at Columbia University in New York, upheld the decision to keep the banks open and encouraged other developed nations, particularly Greece, to impose similar capital controls and restrictions on the convertibility of deposits into currency in times of crisis.

Mr Steinsson says of the experience, “We felt it was imperative in limiting the damage the financial crisis had on the economy that the payment functions of the banking system continued operating at all times. Even relatively short-term interruption of normal payment functions by banks can lead to a massive cascade of delinquencies across the whole economy, magnifying an already dire situation.”

These controls were not a quick fix. Iceland has only just lifted the measures and will now impose a one-off 39 per cent tax on the failed banks’ assets. Local businesses have breathed a sigh of relief at the news, as many feel the controls have deterred overseas investors from putting money into Iceland. This restriction on the flow of foreign capital has also been blamed for inflating the prices of many Icelandic assets.

Very few funds offer exposure to Iceland, and those that do have very little. The best performing of the five UK funds with some investment in Iceland– the Monthly High Income fund from Schroders – is invested primarily in UK fixed interest, but has a 1.1 per cent exposure to Iceland.

Elsewhere, Standard Life’s Global Corporate Bond fund invests in an unsecured three-year bond purchased through Arion, the bank that bought out Kaupthing when it failed in 2008. These bonds are the first issuance of wholesale debt since the crisis, signalling an improving macroeconomic climate.