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Icelandic banks are vulnerable

Thore Johnsen, professor of finance at the Norwegian School of Economics and Business Administration, warns against the possible collapse of Icelandic banks in recent interviews with Norway’s Dagens Næringsliv, Icelandic State Radio, RÚV, and Icelandic daily Morgunblaðið.

Professor Johnsen was commissioned by the Norwegian financial regulatory authorities to undertake a study of the Icelandic banking system late last year in connection with the acquisition of the Norwegian BN Bank by Íslandsbanki.

Iceland’s three largest banks, Kaupthing, Íslandsbanki and Landsbanki, now account for almost half of the market capitalization of the Icelandic stock exchange. If all banks were to experience difficulties at the same time, they could come down “like a house of cards” says professor Johnsen according to Morgunblaðið.

Professor Johnsen was surprised by the degree of concentration of ownership of the banks, the extent of cross-holdings, and the near complete absence of foreign capital. He says the banks have grown rapidly, both through acquisitions and increased lending, and that history has shown that banks can have difficulty in managing rapid growth. In his view it is unlikely that the banks will have difficulties while the global and domestic economies are healthy, but should there be any deterioration of conditions on either front, the banks could come to trouble fast.

“The market capitalization of the banks and their income has increased rapidly. But the income is to a substantial degree derived from the appreciation of shares in the Icelandic market where the banks are the largest and most active traders. The rapid growth of banks in a small, homogeneous economic system, on a small exchange with concentrated ownership is invitation for trouble,” he says in today’s Morgunblaðið.

“The situation is reminiscent of Japan in the late eighties or Norway in the early nineties, in both cases government intervention was eventually needed,” said professor Johnsen in Morgunblaðið. “It does not have to end this way, but if I were the Director of the Central Bank of Iceland, I would be worried,” he said.

As remedy he prescribes higher interest rates and possibly stipulations for increased equity ratios. “The banks are private institutions,” he said, “no-one can tell their management how to act.” Overall, the capital structure of the banks is sound, the equity ratios are more than adequate, “when it comes to investing share capital in the banks, somehow there seems to be no end to the funds available in the Icelandic market,” said professor Johnsen.

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