Daily Telegraph article on the Icelandic collpase

Posted 08/10/2009 - 05:35 by expat

One year on, questions about Iceland’s banking collapse still remain
It is a year since the Icelandic banks failed and neither the British nor the Icelandic government have told the whole story of how and why they fell.

By Sigrun Davidsdottir in the Daily Telegraph
Published: 7:14PM BST 07 Oct 2009

“How could a bank apparently be well financed last summer and then go bankrupt in autumn?” asked a big client of one of the Icelandic banks when I spoke to him recently. The short answer is that banking is an elusive business based on trust – and trust was in short supply when the three Icelandic banks, Kaupthing, Landsbanki and Glitnir, failed last October.

The long answer as to why the three Icelandic banks collapsed so spectacularly will hopefully be answered in a forthcoming report by an Icelandic parliamentary commission. The word is already out that the saga will be a sinister one. An office of a special prosecutor set up in Iceland to deal with alleged fraud related to the banks underlines this message. This new Icelandic saga has a UK ramification: the prosecutor now co-operates with the Serious Fraud Office. However, the UK authorities have never clarified their action against the Icelandic banks a year ago.

Privatisation of the Icelandic banking sector was initiated in the late 1990s followed by the familiar pattern of revaluation of assets causing a boom, further fuelled by the international flush of credit. As seen elsewhere, Icelandic politicians cheered the banks on in awe, unwilling to restrain them with reasonable supervision. The close personal ties invariably found in small countries were widely known – and alarming. The banks were enfeebled by their many large exposures to very few people, by financing purchase of their own or the other banks’ shares and by poor corporate governance. The banks’ interconnections made it likely that should one fail, they all would.

However, British ministers assured Parliament in the summer of 2008 that the growing deposits in Icelandic banks in the UK were under control. The Financial Services Authority had not objected to Landsbanki and Kaupthing’s internet accounts – Icesave opened in 2006, Kaupthing Edge as late as February 2008. Gordon Brown, the Prime Minister, and other ministers have claimed that because of EU regulations the Icelandic banks were free to operate in the UK. That is a feeble answer: it is clearly wrong to claim that foreign banks can operate in the UK under more lax rules than UK banks. The approach towards the Icelandic banks is yet another example of the UK’s light-touch regulation.

What were the specific circumstances leading to the Icelandic demise? In early September 2008 the European Central Bank announced it would tighten its lending rules – a clear threat to Lehman Brothers and Glitnir. Lehman failed on September 15; two weeks later Glitnir followed. On October 7 Landsbanki was taken over by the Icelandic supervisory authorities.

Though it should have been clear to Icelandic authorities how intertwined the fates of the country’s three banks were, it was strongly believed at the time that Kaupthing, the biggest, would survive – it procured a €500m (£463m) loan from the Icelandic Central Bank on October 6. But this didn’t solve Kaupthing’s liquidity problems in the UK: on October 8 the Treasury stepped in to transfer Kaupthing Edge to ING, a Dutch bank, whereby Singer & Friedlander, Kaupthing’s subsidiary, failed, causing Kaupthing, the Icelandic mother company, to default.

A much harsher fate befell Landsbanki: although defaulted in Iceland the Treasury put out a freezing order on Landsbanki by using the Anti-Terrorism, Crime and Security Act 2001. The Treasury believed that “action to the detriment of the UK’s economy (or part of it) has been or is likely to be taken by certain persons who are the government of or resident of a country or territory outside the UK”.

This Delphic utterance meant that suddenly the Anti-Terrorism Act was able to target the whole of Iceland, with serious effect for the country’s companies and individuals. It took weeks for the Treasury to define the target more accurately. However, the Treasury has never clarified why this nuclear option was necessary. What dreadful deeds did the Treasury so fear that only the Anti-Terrorism Act would do? Or was this only an unfortunate sign of nerves?

There has been no answer as yet – and neither has the whole story of the UK intervention been told: the truth is that on Friday, October 3, the FSA had already required Kaupthing’s and Landsbanki’s subsidiaries to place with the Bank of England the banks’ deposits from October 2 and 3. The FSA was obviously getting worried: after all, 170,000 clients had put £2.6bn into Kaupthing Edge and 300,000 clients had put £4bn in Icesave. Since the demise of Northern Rock the British government had been adamant that private deposit holders would not lose a penny.

Kaupthing complied but nothing came from Heritable, Landsbanki’s subsidiary, so on October 6 the FSA asked Heritable to sign over money held with Barclays and HSBC. The next day the Treasury transferred Heritable’s deposits to the Dutch bank ING. And, as mentioned above, it did the same with Kaupthing Edge on October 8.

There are several intriguing questions that the Treasury has never answered: why did it transfer the deposits from the Icelandic banks to a Dutch bank – one that needed to be saved by the Dutch government only a few days later? There are most likely wheels within wheels here: ING was yet another threat to the volatile UK financial sector, it got financial help for sorting out the Icelandic problem and as a consequence ING was strengthened – until the Dutch government bailed it out. By using ING the Treasury cleverly solved two problems with one action.

Now, a year later, many EU central bankers feel that Iceland was unjustly hit by unclear EU directives on deposits as Iceland struggled with the Icesave debts. The Icelandic government has not clarified what it knew of the UK action on October 3 – and possibly earlier, if the Icelandic Central Bank knew that the FSA had taken action against Kaupthing before the loan of €500m was issued. It is unclear why the British government was so complacent in the summer of 2008. The Government has kept quiet as to why the Dutch bank was used, what necessitated the use of the Anti-Terrorism Act – and it’s still a mystery why the Icelandic banks were allowed to operate unfettered in the UK.

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