Vol 7 (2010) - Issue 4

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Iceland Meltdown: Do They Have the Tools or the Appetite to Escape Their Current Predicament?

Overview
Iceland’s attempted diversification from fishing to finance saw its banks expand beyond control to reach ten times the nation’s annual GDP. When the over leveraged banks were unable to meet their liquidity requirements the Icelandic Central bank was unable to act as lender of last resort and the financial system imploded. One year after the collapse there has still been little restructuring action, both financial and operational despite a flurry of activity in the UK and other European countries. Why?

The discussion below shows why there appears to have been little progress made and what needs to be done to turn around the nation.

The size of the problem
Iceland is set to become the most indebted country in Europe with a national debt of 261% of GDP. The Icelandic krona has lost nearly half its value since before the banking collapse. Many Icelanders took out low interest loans in foreign currencies, provided by their Icelandic banks, that are now many times higher than the cars and homes they were used to buy. For an island that imports the majority of its goods and services, the reduction in buying power of the krona has caused a dramatic increase in the cost of imported goods. With import prices increasing and unemployment and disposable incomes rapidly contracting, businesses are finding it increasingly difficult to survive – shown recently in McDonald’s closing all their Icelandic restaurants Average real disposable wages also fell by an estimated 15% on 2008 levels, coupled with an inflation rate of over 10% in 2009. The Economist Intelligence Unit expects this to deteriorate further in 2010.

Barriers to progress 'Fairness'
There has been a lot of political posturing and fingerpointing within Iceland since the banking collapse, coupled with vast staffing changes within most banks. The concept of 'fairness' is also important, given the small population of only 300,000, and many company directors in Iceland know each other. The extent to which banks write off loans, convert debt to equity or change terms to reflect the new economic reality would be widely shared within the financial community, restricting the ability of banks to differentiate remedies between different corporates.

There is also concern about apparently rewarding over-leveraged corporates by writing off the debt that assisted recent growth plans, compared to more cautious companies who maintained low debt levels at the expense of more modest revenue growth.

Tools
The current Icelandic insolvency legal regime is basic. Being derived from historic bankruptcy legislation it lacks the speed and flexibility of more developed legislative climates such as the UK.