Wednesday 21 August 2019

The Iceland man cometh

Interview: Már Guðmundsson - Governor of Iceland's Central Bank

Már Guomundsson chats with the Governor of the Central Bank of Ireland, Patrick Honohan, during his visit to Dublin
Már Guomundsson chats with the Governor of the Central Bank of Ireland, Patrick Honohan, during his visit to Dublin

A country that begins with I and ends with land. A banking crash. Economic meltdown. But that’s where the similarities end between Ireland and Iceland. Its top banker tells Colm Kelpie how his nation fared after burning the bondholders

Már Guomundsson, the Central Bank governor of Iceland, is careful about making comparisons with Ireland. But it's hard not to. Both countries suffered banking crashes around the same period and both countries have paid the price.

Both Ireland and Iceland had financial systems far in excess of what they should have been. In Iceland's case, its banking system held assets that at one stage were worth a staggering ten times the value of its economy.

In the first week of October 2008 - about a week after the bank guarantee in Ireland - almost 90pc of Iceland's banking sector collapsed.

And what made it worse, was that at that point Iceland was already careering towards recession thanks to an unsustainable boom and overheating in the previous years, fuelled by macroeconomic mismanagement, and a currency crisis in the first half of 2008.

Now both countries are on the path to recovery, although Iceland is arguably further ahead on its journey in some respects.

Unemployment in the Nordic island nation is now at 4pc. Gross debt was 90pc in 2013, and is continuing to fall.

But the experiences of both countries differ in many respects.

The island state of just 325,000 people was brought to the verge of bankruptcy in 2008 when three banks collapsed during the global financial crisis. In just five years, the sector had grown from a combined balance sheet of less than twice the state's gross domestic product, to 10 times, with most of the expansion taking place outside of Iceland itself. Around two-thirds of the combined balance sheet was in foreign currencies.

Unlike in Ireland's case, Iceland chose not to take on the cost of the collapse of its banks. And unlike Ireland, bondholders were burned.

Guomundsson says Iceland was a trailblazer.

"I don't think we can allow big banks to be built up on the implicit assumption that if something goes wrong, the government and the taxpayer will step in and make everything good," he tells the Irish Independent, on a visit to Dublin.

"Because if you do that, then these people will take much more risk than otherwise, and that will be dangerous. I sometimes say Iceland did its bit to fight moral hazard and help for the future."

Iceland infuriated some European countries which were left on the hook for billions in compensation to depositors in failed Icelandic banks after its 2008 financial collapse and bankruptcy of its three main banks.

Those banks - Glitnir, Landsbanki and Kaupthing - all went bust during the crisis. Landsbanki had big retail operations abroad, accepting deposits particularly in Britain and the Netherlands under the brand name "Icesave". When it failed, Iceland's banking insurance scheme was unable to cover those deposits, setting the stage for years of international litigation.

But it's wrong to say the country had a choice in not covering the cost of the collapse, says Guomundsson. And it's wrong to compare Iceland's approach to burning the bondholders with Ireland's controversial option not to, he suggests.

"We found ourselves in a very different situation than Ireland in this regard, because two-thirds of the balance sheet of the [Icelandic] banks were in foreign currencies, and three-fourths of the liability sides of the banks were in foreign currency," says Guomundsson.

"The euro is the domestic currency of Ireland. And the European Central Bank was providing liquidity for the Irish banks, keeping them alive. It is one thing to guarantee a bank in your own currency, it is another one to do it in somebody else's currency. If we had tried that, we would have been bankrupt by now, several times over.

"Iceland had absolutely no choice. You could say that Ireland had a choice, or maybe it hadn't. At least, formally speaking it had a choice. I am not going to pass judgement on anything that was done in this country."

In Iceland's case, he says international experts at the time recognised that Iceland had no choice.

"The International Monetary Fund (IMF) came in four months after the event, but I don't think that they for a minute doubted that this was the only sort of decision that we could have taken," he says.

"If you look at the discussion now, not only among economists, but what is being contemplated at the European Union level, in terms of the framework for banking resolution, this is pretty standard. But it was not well received at the time."

Although denied by former ECB President Jean-Claude Trichet, it is argued that Ireland came under intense pressure from Europe not to burn bondholders. I wonder if Iceland had more options at its disposal because it wasn't part of a currency union.

Guomundsson is philosophical as he weighs up the pros and cons, saying the jury is still out.

The ECB, he says, was keeping Irish banks alive. Iceland didn't have that safety net. And Iceland suffered a currency crisis, pushing real wages down considerably. "What would we have done in the same situation as Ireland? I don't know. It is difficult to say. One of the problems in Iceland was that we had a currency crisis, but you avoided a currency crisis because you were part of the Eurozone," he says.

"The currency crisis was very difficult for us because we had a lot of debt inside the country that was denominated in foreign currencies. So the debt burden increased for households and corporates, that intensified the downturn. But subsequently, the low real exchange rate stimulated the tourism sector and that helped the recovery."

But despite Iceland's economic turnaround, the country isn't out of the woods yet. And that's because capital controls imposed at the height of the crisis remain in place.

Moves are afoot to have them wound down, which when completed will bring the country in from the financial cold and signal a return to the international financial community. But Guomundsson says it isn't an easy task.

"There are very big impediments and there are very good reasons why we haven't lifted them already," he says.

"The biggest impediment is related to the resolution of the banks. Because 94pc of the claims on banks are foreign and 6pc are domestic."

Iceland hopes that by finally lifting capital controls it can draw a line under the crisis, restore its credit rating, lower its borrowing costs, boost its economy and revive the living standards of its 330,000 people. But to do so, it must find a way to let investors withdraw funds without provoking a catastrophic stampede.

"The basic principle is clear: you need to reduce the amount of domestic assets that seek a speedy exit once the controls are lifted," Guomundsson says.

Officials say they will put rules in place to ensure a managed, not free, float of the currency. The government is reportedly considering taxing the removal of cash to prevent an exodus.

Guomundsson says the Icelandic government has hired a raft of international experts to advise the country on how to proceed, including JP Morgan, and he is confident a solution can be found.

With Iceland and Ireland now experiencing similar growth rates, (the IMF forecasts Iceland's GDP will rise by 3.5pc this year and 3.2pc next year) I wonder if it is possible, as Finance Minister Michael Noonan hopes, to break the cycle of boom and bust that countries such as Ireland have endured.

"We don't know the answer to that. We can mitigate this. If we are not wise after the event, then when are we going to be wise?

"We are duty bound to try to build policy frameworks, regulation and supervision that makes the likelihood of boom and bust much smaller."

He's clearly a thoughtful, reflective individual.

Does he have any advice for Ireland? The answer is brief.

"Perseverance," he says.

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