Central Bank Was Wrong to Grant Loan During Banking Collapse Skip to content

Central Bank Was Wrong to Grant Loan During Banking Collapse

By Yelena

Central Bank of Iceland
Photo: Golli. Central Bank of Iceland.

Central Bank of Iceland Director Már Guðmundsson says that the institution made the wrong decision when it granted a loan to Kaupþing Bank during the banking collapse, RÚV reports. The Central Bank has published a report on the controversial ISK 75 billion ($605m/541m) loan, which it granted to Kaupþing Bank just days before it went bankrupt in the 2008 economic crisis. The report states, however, that no laws were broken in the granting of the loan.

The Central Bank of Iceland granted Kaupþing Bank an ISK 75 billion ($605m/541m) loan on October 9, 2008, just before emergency trading restrictions were put in place by the government. Kaupþing went bankrupt only two days later, leading to a loss for the Central Bank purportedly amounting to ISK 35 billion ($282m/€252m). The decision to grant the loan proved controversial and the reasoning behind it opaque.

No written documentation

The main objective of the recently published report was to clarify the reasoning behind the loan. It has been in the works since 2015 and its release was repeatedly postponed. The report states that information on the loan is lacking, making it difficult to determing the reasoning behind it. Notably, there is no written documentation that Kaupþing requested a loan in the first place. There is also no evidence that the Central Bank’s Board of Directors approved the loan. There is, however, no doubt that the decision was made by the Board in consultation with then-Prime Minister Geir H. Haarde.

Geir was highly criticised for his response to the banking collapse and tried by the High Court in Iceland, which convincted him on one the four charges, namely, not having held cabinet meetings on important matters in the lead-up to the economic collapse. A recorded telephone conversation reveals that Geir did not expect the loan granted to Kaupþing to be repaid.

Hindsight and lessons

Although hindsight reveals that granting Kaupþing a loan was the wrong decision, Már asserted that it was not clear at the time the decision was made. The loan would have been justified had it succeeded in rescuing the bank. “It’s not always appropriate to use the metrics of information of later times when assessing particular decisions. In the financial whirlwind that raged around the world then, banks and central banks were fighting to stay afloat and other authorities came to their aid.”

Már stated that two important lessons can be learned from the situation. The first is that regulations on the granting of emergency loans need to be better clarified. The second is that shares in foreign banks are not suitable collateral for such loans, as it can quickly become worthless in a financial crisis.

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