The Icelandic Financial Crisis

Protest in Iceland 2008

What led to the Icelandic financial crisis in 2008? What were the consequences of this troubled economy, and how did the nation manage to recover? Read on to learn more about this dark chapter in Icelandic history. 

Understand that the world of finance is shadowy and complex. Going forward, we will attempt to break the details down so as to be accessible for most readers. 

Even so, the fluctuations of a local economy – let alone a global market – is a subject one could devote their lives to without fully understanding its details. 

In fact, it is from within that misunderstanding that the foundation of this article is laid. 

So, let’s begin with the basics.

How do Icelanders view money?  

Finances in Iceland
Photo: Golli. Stacks of Icelandic krona.

For most people, money can be simplified into earning enough to pay for one’s food, shelter, and entertainment. Putting it bluntly, making money is the engine that drives societies such as ours, and oftentimes, it is from one’s occupation that people derive meaning.

Icelanders are no different in this respect, often choosing to pursue career opportunities that satiate their personal goals rather than mere financial gain. 

Ultimately, the majority of folk – Icelanders included – are content accepting that money is not the be-all and end-all in life. Instead, it is better looked at as a means of securing a comfortable and engaging life.

Shopping in Iceland
Photo: Golli. Icelanders shopping in downtown Reykjavik.

However, some people have a rather different opinion. For bankers, investors, and financial analysts, the concept of money is a constant back-and-forth that involves borrowing, interest rates, debts, and keeping a close eye on international markets. 

As is to be expected, this latter group can often have a great impact on the former, regardless of whether the results are desired or not. Such a philosophy even has a name – crony capitalism

As it so happens, Iceland is a capitalist country; one with a small population that has yet to surpass 400,000 people. Given this pairing, nepotism and corruption have long been a reality of life here. Some people continue to believe that personal gain, both for the individual and those closest to them, trumps what might be more beneficial for the nation at large. 

In that sense, Iceland is hardly different than anywhere else. But unfortunately, the consequences of such selfish thinking tend to impact a greater percentage of people on a small island than it might otherwise do in a larger, less corruptible republic.

What happens when the markets crash? 

 

 

One of the most dramatic economic events to affect life in Iceland began in 2008. The grand scale of it cannot be overemphasised, and not just for those living here. In fact, 2008 was one of the first times in history that the entire world turned its attention to this small Nordic island. 

As you might imagine, this spotlight was not cast for the best of reasons… We talk, of course, about the Icelandic financial crash. 

It was not purely Iceland’s economic woes that drew people’s notice. Rather, it was how these troubles influenced global events, particularly the markets in their own countries.

The Icelandic financial crash is often considered to be the straw that broke the camel’s back in regards to the global recession that would follow. It was, by most accounts, the first pillar to topple what had, until then, been thought of as a profitable and structurally sound pecuniary model the world over.

What led to the Icelandic financial crisis? 

Íslandsbanki headquarters in Reykjavík
Photo: Golli. Íslandsbanki headquarters in Reykjavík

The origins of the financial crash in Iceland can be traced to 2001. It was in that year that the banks were deregulated. In essence, this deregulation meant that Icelandic banks – namely, Landsbanki, Glitnir, and Kaupthing – could all operate using foreign currency. In the short term, this proved to work wonders for the Icelandic economy, as it continued to experience rapid growth right up until 2008. 

With deregulation came the need for banks to expand. This expansion could only be achieved with the adoption of increasingly aggressive lending practices aimed at both residents in Iceland, and those living beyond its shores. In particular, the real estate sector proved to be the juiciest target.    

The expansion of the banks was bolstered by taking loans from the interbank lending market. They also increased levels of external debt by taking deposits from outside of the country. 

As early as 2007, The Economist magazine ranked the Icelandic krona as the most overvalued currency in the world. For many, this should have been a clear indicator that local financial practices were not sustainable.

Waves crashing over Reykjavík lighthouse
Photo: Golli. Waves crash over lighthouse in Reykjavík winter storm

When an economic bubble bursts… 


However, little consideration was given to the fact that there was no lender of last resort. When it came to refinance the debts accumulated, it quickly became apparent that the banks had no foreign currency to pay them off.

Around this time, household debt also rose to 213% of a family’s disposable income. This imbalance soon led to inflation, which in turn, forced a hike in interest rates. In response, the Central Bank of Iceland began offering liquidity loans to other banks based solely on newly-issued bonds. 

While this might sound complicated, understand it for what it really was – the Central Bank was doing little more than printing new money. 

By September 2018, interest rates in Iceland were at 15.5%, far higher than in other European countries. For example, the United Kingdom only held interest rates at 5% at that time. This divide caused foreign investors to withhold depositing Icelandic krona, creating even higher monetary inflation, and ultimately, an economic bubble within which financiers continued to overestimate the value of Iceland’s currency.

What were the consequences of the Icelandic financial crash? 

Bjarni Benediktsson icelandic politics
Photo: Golli. Former minister of Finance, Bjarni Benediktsson

In the years leading up to the crisis, Iceland’s economy was extremely reliant on its financial sector. Following the closure of its banks, both businesses and individuals immediately felt the shockwaves. 

Having been valued far too highly for far too long, the worth of the Icelandic krona dropped considerably. As a consequence of this devaluation, many Icelanders lost their life savings, and unemployment rose considerably. It was the first sign of the recession to come, not just in Iceland, but around the world.

Overseas, it was those who held close ties to Icelandic banks that suffered the most. Beyond the tribulations these investors felt personally, the losses they accumulated through their association with Iceland would further contribute to the broader global crash.

The government’s last stand 

Alþingi parliament of Iceland
Photo: Golli. Alþingi, the Parliament of Iceland

Even amongst casual observers, the writing on the wall was obvious. And so, when the Icelandic banking system collapsed, few people were shocked by it. 

Now in the midst of a recession they had partly caused – plus no banking system to speak of – the Icelandic government quickly found themselves faced with enormous pressure to stabilise the economy. It would prove to be a challenging balance act between satisfying the demands for accountability with practical steps to prevent any further collapse from happening. 

In doing so, the government introduced sweeping changes across the financial sector. These included implementing capital controls to help steady the currency, as well as bailing out, restructuring, and nationalising the banks. Not only that; the government also chased down fiscal stimulus programs that might help boost economic recovery, as well engaged in negotiations with international creditors. 

Central Bank Ásgeir Jónsson seðlabankastjóri
Photo: Golli. Current Central Bank Governor, Ásgeir Jónsson

Still, many ministers realised they would soon be forced to resign, and mass protests – some of which became violent – continued to plague those responsible for leading the country. Iceland’s leaders realised quickly what others already knew; the road to full economic recovery would be a long and arduous journey. 

But even having come to this conclusion, there was no resting easy for government officials, nor those in charge of Iceland’s beaten down banks. As it stood, trust in the country’s financial institutions was at an all time low.

Resilient as ever, the Icelandic people demanded blood. And one way or another, they would get it. 

The Icelandic People demanded change

Photo: Golli. Pots and pans revolution protest outside of Alþingi, Iceland’s Parliament.

In true Icelandic style, the protests began with a single man – a popular songwriter by the name of Hörður Torfason. Having staged himself with a microphone outside of the parliament building on Austurvöllur, he invited others to express their frustration with the government. 

By the following week, these protests had become larger and more demonstrative. Participants organised themselves into an outfit called Raddir fólksins (Voices of the People.) They promised to vent their anger every Saturday until the government stepped down.

 

 

These protests would come to be known as the Kitchenware Revolution, or by others, the Pots and Pans Protests. As part of the growing unrest, the largest protest ever to take place in Iceland happened on 20 January 2009. 

These protests largely came to an end following the resignation of members of the Independence Party. In its place, a new left-wing government was formed, having had the support of the protesters. Iceland’s former prime minister, Geir Haarde, faced prosecution at Landsdómur, or the National Court, though ultimately, he would be found non-culpable.  

Recovery from the Icelandic Financial Crisis

Photo: Bjarki Sigursveinsson. CC. Flickr. Eyjafjallajökull erupts!

Whereas other countries opted for austerity, bank bailouts, and low inflation, Iceland decided to go in another direction. It would be a risky reaction that actually turned out to work in its favour. But aside from the changes mentioned, the tourism boom would ultimately be the saving grace in rebuilding Iceland’s economy.

Sudden interest in the country peaked during the 2010 eruption at Eyjafjallajökull. Putting that in the timeline, this event occurred a little over halfway into the financial crisis. For locals, the eruption was an uncomfortable distraction from their recently emptied wallets. But for many abroad, it was their first introduction to what would become known as the land of ice and fire.

 

 

Global news coverage broadcast compelling images of this dramatic geological event. A snow-laden mountain scorched with fire. A black column of ash and glass filling an empty blue sky. That last sentence is particularly accurate. The density of the ash pushed into the atmosphere created enormous disruptions in air travel, and many passengers found themselves stranded, waiting for the eruption to end and the air to clear. 

These pictures – and numerous flight cancellations – filled people with curiosity as to what life in Iceland was really like. It was an inquisitiveness bolstered with fascinating B-roll of Iceland’s nature; of dark pebble beaches, sweeping white glaciers, endless moss-covered lava fields. Before Icelanders had a chance to prepare themselves for the societal changes that tourism would bring, excited vacationers were booking their tickets. 

Fireworks on New Year's Eve.
Photo: Golli. Fireworks on New Year’s Eve.

Rebuilding the Icelandic Nation 


By 2012, Iceland’s miraculous recovery was being cited as a success story among other nations. Unemployment rates had dropped to 6.3%, partly on account of how Icelandic officials began to appeal to immigrants.

In April of the next year, a new government was formed, setting about a process by which many of the former bank directors were sentenced for their part in the financial meltdown of 2008.

As of today, the consequences of this dark and complex time continue to reveal themselves. For example, Iceland is still very dependent on tourism, pouring billions of krona into marketing campaigns each year to ensure it remains a bucket-list destination for prospective travellers.

túristi tourist ferðamaður tourism
Golli. Tourists in front of Esja on Sæbraut in Reykjavík

Government officials must also continue to balance the debts they incurred attempting to pull the island out from its economic woes.

Finally, much of public discourse has been shaped by these events, and stricter measures on lending, borrowing, and trading remain in place so as to avoid repeating mistakes of the past.

Going forward, we can only hope these lessons have been learned for the last time. 

Central Bank Governor to Stay On

Ásgeir Jónsson, Governor of the Central Bank of Iceland

Ásgeir Jónsson, the Governor of the Central Bank of Iceland, will stay on until the year 2029, RÚV reports.

The Governor’s term was set to end August 20 this year. According to law, Prime Minister Katrín Jakobsdóttir would have had to inform Ásgeir with a six months notice if the position were to be opened for other candidates. This did not take place and Ásgeir’s tenure was therefore automatically extended for five years.

Tumultuous term in office

Ásgeir was appointed in 2019 and has faced challenges during his term. The Covid-19 pandemic affected the economy greatly and the Central Bank’s response was to drive down interest rates to fuel economic activity. At their lowest, they were 0.75%, the lowest rate in Iceland’s history.

After the pandemic, inflation has been high and persistent. Since mid-2021, interest rates have steadily gone up and now stand at 9.25%.

New Payment App to Launch in 2024

Smartphone

The Central Bank of Iceland is spearheading a new mobile payment app for smartphones to be introduced as early as fall of 2024, Heimildin reports. When up and running, the app should help lower prices and stabilise payment systems, according to Central Bank Deputy Governor Gunnar Jakobsson. Over 90 percent of transactions in Iceland are now made with payment cards.

Similar to apps in Denmark, Sweden and Poland

Icelandic financial institutions and the Central Bank have agreed on developing the peer-to-peer payment solution that would allow consumers to purchase goods and services without using the payment systems of VISA or Mastercard. The consumer could download this app to their phone and pay with a direct bank transfer. The service would be similar to MobilPay in Denmark, Swish in Sweden and Blik in Poland.

Prime Minister Katrín Jakobsdóttir is expected to introduce a bill requiring financial institutions to participate, which Alþingi will need to pass into law. The goal for the authorities is to increase the stability and security of payment systems in Iceland, with the possible side effect of bringing down costs of financial transactions in the country with a less expensive solution. As it stands, Icelanders spend more on credit card fees than their Nordic counterparts.

Market to dictate who benefits

Only two to three percent of payments in Iceland are concluded with cash payments, with the vast majority made with cards. Gunnar says that this split is unacceptable in the eyes of the Central Bank from a security standpoint. For example, a cyber attack on a service provider in November stopped payments for hours. He argues that a middle solution of simplified bank transfers would increase stability and also reduce the costs that consumers face for their everyday card use.

“It’s often hard to think of the whole picture, but if we manage to lower the cost of payment systems in the country, economics tell us that it should eventually lead to lower prices,” Gunnar told Heimildin. “Who benefits from lower prices, whether it will be the consumer or the provider of goods and services, is something that market competition will dictate.”

Indexed Loans Dominate Mortgage Market

central bank of iceland

As the payment burden of non-indexed loans continues to rise, households are increasingly moving towards indexed loans. Despite rising interest rates, the banks have not seen an increase in defaults, Mbl.is reports.

Inflation expected to remain high

The deteriorating economic outlook in recent months has led to major upheavals in the mortgage market, Mbl.is reports. Although inflation remains high, and although it is likely that inflation will continue to remain high for some time, borrowers are increasingly seeking shelter from the ever-increasing payment burden of non-indexed loans by moving to indexed loans – this despite the fact that real interest rates on non-indexed loans have been negative for some time.

According to statistics from Iceland’s Central Bank, households took out new mortgages in February worth a total of ISK 3.9 billion [$29 million/€26 million]. Of these, new indexed loans amounted to ISK 6 billion [$44 million/€40 million] while the repayment of non-indexed loans amounted to ISK 2.1 billion [$15 million/€14 million], meaning that many borrowers refinanced their loans in order to transition to indexed mortgages. As noted by Mbl.is, households have taken out indexed mortgages for around ISK 21 billion [$154 million/€140 million] since last December and paid off the non-indexed ones by around ISK 3 billion [$22 million/€21 million].

Indexed loans the most popular mortgage since last fall

As noted in a recent In Focus piece on Iceland Review, to mitigate the fallout from the COVID-19 pandemic, Iceland’s Central Bank slashed interest rates to historic lows in 2020. These cuts resulted in a real-estate boom, with many seeking to take advantage of low rates to secure roomier homes or to refinance.

Read More: In Focus: Indexed Mortgages

The majority of new mortgages signed during the pandemic were non-indexed loans with variable interest rates because such loans carry higher initial payments but allow lenders to own their homes sooner; so long as inflation remained low, monthly payments would remain feasible, and lenders would own their homes sooner.

When the key interest rate began to sharply rise last year, however, lenders were faced with an increased payment burden and began to turn increasingly to indexed loans; the variable base interest rates of the banks’ non-indexed mortgages are now in the range of 8%-9.34% compared to 3.3%-4.44% in December 2020.

This large increase in interest rates has not, however, led to increased defaults among the banks’ customers, Mbl.is notes, although the banks recognise that lenders are increasingly switching to indexed mortgages. About half of all non-indexed mortgages have a fixed interest rate; most of them will not be released until the years 2024 and 2025.

Central Bank Raises Interest Rate 1%, Now at 7.5%

central bank of iceland

The Monetary Policy Committee of the Central Bank of Iceland has raised interest rates a further 1%. This is the twelfth rate hike in a row, and key interest rates, that is, the interest rate on seven-day term deposits, now sits at 7.5%.

The interest rate in Iceland has not been higher since 2010, when the Icelandic economy was still recovering from the banking collapse.

Inflation Rate Now 10%, Up 1.39% from January

In a statement released by the Central Bank of Iceland, the rate hikes are described as a response to continuing inflationary pressures. Inflation in Iceland currently sits at 10.2%, far above the Central Bank’s goal. Despite a cooling housing market, the Central Bank still forecasts future increases in the inflation rate.

For comparison, headline inflation rates in Europe currently average around 8.5%. Key European Central Bank interest rates were raised to 3.5% in response to recent upsets in international banking, including the UBS takeover of Credit Suisse.

The Central Bank has also pointed to a tight labour market in Iceland, with tense negotiations between labour unions and employers, and relatively high numbers of job openings, driving up wages.

interest rates in iceland
Central Bank of Iceland: Interest Rate Since Jan 2019

In their statement on the latest rate hike, the Central Bank said: “Under these circumstances, it is important to prevent a wage-price spiral, particularly in view of the strong demand pressures in the economy and the upcoming wage negotiations. The MPC will apply its policy instruments so as to ensure a better balanced economy and bring inflation back to target.”

Interest rates in Iceland now stand as follows:

Overnight loans 9.25%
Seven-day collateralised loans 8.25%
Seven-day term deposits 7.50%
Current accounts 7.25%

Notably, predictions last week estimated the latest rate hike would only account for .75%.

Banks Raise Interest on Non-Indexed Loans

currency iceland

All three of Iceland’s commercial banks announced that they would be raising interest rates on Friday. RÚV reports that Arion Bank, Íslandsbanki, and Landsbankinn are raising interest rates on non-indexed loans, as well as deposits. The hike comes on the heels of a 0.5% increase on key interest rates last week.

Interest rates on most types of non-indexed loans went up by 0.5% at Arion Bank, Íslandsbanki, and Landsbankinn. New non-indexed mortgages offered by Landsbankinn interest rates had a slightly lower hike; those went up 0.25-0.30%.

Read More: Inflation Rate Continues Climb, Now at 9.9% (January 2023)

Non-indexed interest rates on the banks’ home loans are now in the range of 8.0-8.5%, while interest rates on indexed loans remain unchanged.

Deposit rates were also raised, in most cases around 0.5%.

Looking Back: Mortgage Payments Continue Rising in Iceland (August 2022)

Friday’s interest increases come on the heels of the Central Bank’s decision to raise key interest rates by 0.5% last week, bringing it up to 6.5%. This was the Central Bank’s 11th increase on the key interest rate in a row. The lowest this rate has been is 0.75% in the spring of 2021.

Interest rates have not been higher since 2009.

Central Bank Raises Key Interest Rates by 0.5%

Central Bank Ásgeir Jónsson seðlabankastjóri

The Monetary Policy Committee of Iceland’s Central Bank has announced that it will be raising key interest rates by 0.5%, with short-term interest rates (seven-day term deposits) now sitting at 6.5%, RÚV reports. Although the housing market has cooled, and global inflation slightly eased, inflationary pressures remain high.

Inflation outlook worsened

At a briefing held at the Culture House in Reykjavík this morning (there is construction work ongoing within the Central Bank’s meeting hall), the Monetary Policy Committee (MPC) of the Central Bank announced its decision to raise key interest rates by 0.5%.

As noted in the Statement of the Monetary Policy Committee published this morning, although the housing market has begun to cool and global inflation has eased slightly, “inflationary pressures are still pronounced” and price increases “widespread:”

“The inflation outlook has worsened since the MPC’s last meeting, and although inflation has most likely peaked, bringing it back to target [rates] will take longer than previously anticipated. The deterioration in the outlook stems in particular from the recently finalised private sector wage agreements, which entail considerably larger pay rises than previously assumed. Furthermore, the króna has depreciated, and the outlook is for a larger positive output gap during the forecast horizon,” the statement reads.

More restraint required in the near future

As noted by RÚV, inflation increased in January and was recorded at 9.9%. In light of this, the MPC believes that it is necessary to increase restraints in the near future in order for inflation to subside. According to the Monetary Bulletin, inflation is expected to average 9.5% in the first quarter of this year, which is 1% more than was expected in November.

International inflation remains high even though it has subsided from last year’s peak, and there remains considerable uncertainty about the economic outlook, the Monetary Bulletin notes. The progress of the war in Ukraine will have a lot to do with international economic development, which will inevitably also affect this country.

The Monetary Bulletin also states that, according to the Bank’s new macroeconomic forecast, GDP growth in 2022 measured 7.1%: “far above the November forecast and, if the forecast materialises, the strongest GDP growth rate since 2007. GDP growth is set to weaken in 2023 but the labour market is expected to remain tight, however.”

First-Time Buyers at Seven-Year Low

Reykjavík sunset cityscape

The number of first-time property buyers on Iceland’s housing market has dropped dramatically since the Central Bank of Iceland tightened loan requirements in June 2022, RÚV reports. First-time buyers have not been such a low proportion of real-estate purchasers in seven years.

In June last year, the Central Bank’s Financial Stability Committee lowered the maximum loan-to-value ratio on mortgage loans to first-time buyers from 90% to 85%. The debt-to-income ratio for first-time buyers was also set at 40%. These were just two of the changes made that tightened regulations on loans to this group. Central Bank Governor Ásgeir Jónsson stated the changes were intended to protect young people and cool the housing market.

“When the Central Bank of Iceland applied these measures, [the governor] talked about how it would be more difficult for first-time buyers to enter the market, and that has proven to be the case,” stated Kári S. Friðriksson, an economist at the Housing and Construction Authority (HMS).

Reversal of trend

The year 2021 was advantageous for first-time buyers: in the first quarter, they reached an all-time record of 1,941 in number. In the second quarter their average age dropped to 29, the lowest since 2006. In the third quarter of 2021, first-time buyers rose to a record 33.8%. Now tightened mortgage regulations and raised interest rates appear to have reversed those trends. In the last quarter, first-time buyers had dropped to 26.5% and numbered 900 – less than half the number in the first quarter of 2021.

Kári stated he would not be surprised if the current situation on the housing market would lead to a rise in rental prices. “They have actually risen quite little both considering housing prices and considering wages for several years now.”

Central Bank Working on Domestic Payment System

currency iceland

The Central Bank of Iceland is working to develop a domestic payment system for Iceland.

As more and more transactions become electronic, interest has grown in an independent payment system for Icelandic commerce. Cyberattacks or other disruptions to service in the several foreign payment systems on which so many Icelandic businesses currently rely could cause serious disruption to economic life in Iceland. By working towards a secure and independent solution, the Central Bank of Iceland hopes to make the Icelandic economy more resilient to risk in the future.

The Central Bank of Iceland has begun taking initial steps at the request of Iceland’s National Security Council, in line with steps taken recently by other European nations. The Central Bank plans to publish a report on the matter in the coming months, in which possible ways forward will be considered.

The Central Bank’s recent report on financial cybersecurity indicated the real possibility of long-term disruption to the payment system following a cyberattack on a foreign payment system. According to the Central Bank, other means of payment need to be provided to ensure that necessities can still be purchased in the event of such an attack. In addition to a domestic payment system, the Central Bank has also called for the creation of preparedness plans in the event of such a disruption.

The need for a secure, domestic payment system is especially pressing in Iceland, where fewer and fewer transactions take place with cash. In the past two years, the use of cash in purchases has declined by some 25%, although it is still used by some 40% of the population, especially for gifts and personal payments. In the event of an electronic payment disruption, the Central Bank has stated, there are still enough cash reserves to address such an event.

 

 

 

Deep North Episode 6: Indexed Mortgages

indexed loan iceland

In the tug-of-war game between interest rates and inflation following the economic disruptions of COVID-19, Icelandic homeowners have been put under increasing pressure. We talk about a rather unique feature of the Icelandic financial system and its effects on Icelandic families.

Read more about indexed loans in our recent In Focus piece.