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Document Type

Case Study

Case Series

Account Guarantee Programs

JEL Codes

G01, G28

Abstract

Leading up to the Global Financial Crisis of 2007–2009, Iceland’s three largest banks accumulated assets totaling several times the size of Iceland’s GDP and financed their growth through foreign borrowing. As wholesale funding dried up in 2007, they replaced this borrowing by rapidly gathering deposits through foreign branches and subsidiaries located in the European Union, primarily in the United Kingdom and the Netherlands. In the summer and fall of 2008, international credit markets froze and the Icelandic banks were unable to roll over their maturing liabilities. On October 6, Prime Minister Geir Haarde announced a full guarantee of domestic deposits. He excluded foreign depositors, who made up about two-thirds of the three banks’ deposits. The Icelandic Parliament passed emergency legislation allowing the Financial Supervisory Authority (FME) to take control of the banks and place them in receivership. The government placed all three banks into resolution within two weeks. The Ministry of Finance created new banks out of the old banks’ assets and liabilities, including domestic deposits, and injected government funds to restore their capital, dividing ownership between the Icelandic government and the old banks’ creditors. The Icelandic government also received an extensive support package from the IMF and loans from foreign governments. Domestic depositors never lost access to their funds. The UK and Dutch governments paid the banks’ retail depositors located in their countries’ branches in December 2008 and sought reimbursement from the Icelandic deposit insurance fund and state. The Icelandic state and foreign parties disagreed over the former’s legal responsibilities to back up the empty deposit insurance fund and to treat foreign and domestic depositors equally. The negotiations, known as the “Icesave dispute,” continued for more than four years. On January 28, 2013, the European Free Trade Association Court ruled that Iceland was not responsible for paying foreign depositors. The UK and Dutch governments received first claims on proceeds from Landsbanki’s bankruptcy estate later that year. The bankruptcy estate made its final payment on January 11, 2016. The Icelandic government officially lifted the full guarantee on September 9, 2016. Scholarly evaluations are generally positive because Iceland preserved its payments system and basic financial services at the height of its banking crisis. Scholars also expressed caution about moral hazard and other unintended market effects associated with an unlimited guarantee.

Date Revised

2022-07-15

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