Iceland's banking sector has recovered impressively from its 2008 collapse, and the banks formed from the ashes of that period are performing well. However, the clouds of the past still linger, and the winding-up processes of the failed Kaupthing, Glitnir and Landsbanki are still to be resolved.

Much has changed in Iceland in the past 15 years. The country's finance industry expanded rapidly after its banks were privatised in early 2000, only to collapse in dramatic fashion in the aftermath of the 2008 financial crisis. This led the country’s three largest commercial banks to collapse and then be nationalised. Their three successor banks have changed their approach, and have since recovered and boosted their capital ratios – but insolvency proceedings at the old banks are still under way.

It was the huge level of foreign debt held by the three banks – Kaupthing, Glitnir and Landsbanki – which caused their collapse. At the end of 2007, Kaupthing recorded $86.5bn of assets, followed by Landsbanki’s $49.4bn and Glitnir with $47.7bn, according to The Banker Database. The banks took deposits not only from Iceland’s population but also from abroad, inflating the banks’ assets to more than 10 times the country’s gross domestic product (GDP) of €8.5bn.

For these reasons, the country’s central bank was unable to rescue the banking sector when things turned sour.

The government took over, winding-up the previous 'big three' and starting anew. This fresh start appears to be paying off, with banking analyst Håkon Reistad Fure at DNB Markets stating that Iceland’s new lenders are “the best capitalised banks in Europe”.

Banking resurrection

Kaupthing’s successor, Arion Bank, is now Iceland's second largest bank by assets and has the third highest Tier 1 capital ratio of 13.38%, as of year-end 2013 figures. Íslandsbanki, Glitnir's successor, is the third largest in the country by assets but has a Tier 1 capital ratio of 19.12%, while Landsbankinn – the 'new' Landsbanki – boasts a Tier 1 capital ratio of 20.57% and the highest level of assets.

“We have seen increasing interest from clients in the Icelandic banking sector,” says Mr Fure, who specialises in financial institutions in Scandinavia and now also covers Iceland. “There has been a strong recovery in the banks’ performances.”

In 2010, the Icelandic banks’ asset quality was worryingly weak, with a ratio of about 21% of problem loans to assets – the equivalent figure in troubled Greece was just over 10%, – according to data accumulated by DNB Markets. By 2013, this ratio in Iceland had recovered to about 6%, while in Greece it had skyrocketed to 34%, and in other eurozone countries impacted by the financial crisis – Ireland, Italy and Spain – ratios rose to above that of Iceland's.

Significant restructuring exercises in the banks’ non-performing loan portfolios (NPL) have caused these ratios to decrease drastically. Arion Bank, for example, lowered its NPL ratio to 5.4% as of the end of June, compared with 56% in 2010, according to Höskuldur Ólafsson, the bank's CEO.

A new approach

This recovery came hand in hand with a rise in core Tier 1 ratios, high equity ratios of above 15% and improved profitability. Returns on capital at the three new banks were between 12.6% and 18.7% in 2013, according to The Banker Database, and the banks are maintaining this strong performance.

“We have had a very strong first half of this year; we saw meaningful loan growth for the first time since 2008 and – based from the figures from our competitors – we are gaining market share,” says Birna Einarsdóttir, CEO of Íslandsbanki. “And we are also very happy to see that [operational] costs are still going down between 7% and 8% in the first half, and that also was the case last year.”

Íslandsbanki, like the country’s other two successor banks, was created out of a failed bank’s domestic operations and now mostly focuses on the Icelandic market. “Outside Iceland, unlike before, we have a very focused approach on the North Atlantic area, mainly in the sectors of seafood and energy, where we think Iceland has some expertise to offer,” says Ms Einarsdóttir. “We have been doing lending in this area and we expect responsible growth in the next few years, but the Icelandic domestic market is always going to be our core business.”

Mortgage focus

Meanwhile, investment banking-focused Kaupthing, which had fast-growing operations in 13 countries, transformed itself into domestic bank Arion Bank, with a strong mortgage finance business.

“Retail banking was not too important at Kaupthing but is very important for locally focused Arion Bank,” says Mr Ólafsson. “When we started to rebuild the bank in 2010, only about 25% of the loan book was retail – our target was 50% and we reached this in 2013.”

The bank now has strong market shares across retail banking, corporate banking, investment banking and asset management. One particularly important area for Arion Bank is the housing market, where it is second in Iceland in terms of market share behind the state-owned housing fund. The bank’s success is widely considered to be related to its introduction of non-index linked mortgages at the end of 2011.

“These products were extremely successful and got the housing market moving again,” says Mr Ólafsson. “Competitors have adopted the same model and now a large proportion of the market has non-index linked mortgage loans.”

With the new banks being more reliant on the economic situation within Iceland, the country’s turnaround is an important achievement. After 2009 and 2010’s 6.6% and 4.1% contractions in real GDP, the country's economy turned around to post GDP growth of 2.7%, 1.5% and 3.3% from 2011 to 2013, according to Eurostat.

The International Monetary Fund (IMF) expects another 2.9% of growth in 2014, driven by private consumption, investments and exports. Íslandsbanki expects to see the ratio of investment to GDP reach 20% for the first time since 2008 in 2016. “This is good news for all banks in Iceland as it indicates that we will continue to see growth in our loan portfolio,” says Ms Einarsdóttir.

The crisis aftermath

But not all is rosy, at least not yet. The Icelandic financial crisis has left some issues unresolved. Because the financial sector made up such a large proportion of the country’s GDP before the crash, the crisis had a serious effect on the economy. The Icelandic krona fell sharply in value, causing the government to enforce strict capital controls. Initially all official currency exchange was suspended, before a new set of rules at least allowed big Icelandic importers and exporters some room for limited currency exchange.

While the 2008 controls were intended to be lifted after a short time, the country is still operating under the controls today.

“It was a necessary evil but in the long run we have abnormal conditions, which gradually lead to adverse effects [for the economy],” says Mr Ólafsson. “We have tremendous investment appetite by the very strong pension funds, which are effectively locked in and can only invest in Iceland, while companies with international business have additional costs. We would also like to see more foreign investment in Iceland but foreign investors are suspicious of these controls, so it is important to start abolishing them in an orderly manner.”

The IMF’s report on Iceland from July 2014 notes that the Icelandic economy has recovered to a healthy position and suggests that the next step should be to lift the capital controls.

Dissenting voices

While the government agrees in principle, the Icelandic Ministry of Finance and Economic Affairs argues in its 'Progress Plan', published in March, for the controls to remain in place to avert possible instability in the currency. An uncontrolled removal, it says, could lead to instability due to an interplay of potential outflows of Icelandic krona assets held by non-residents, domestic parties (for example, pension funds), as well as through contractual instalments by domestic parties on foreign obligations and through the winding-up of the failed banks.

At the end of 2013, offshore Icelandic krona amounted to Ikr327bn ($2.7bn) compared with Ikr565bn in 2008. However, the report argues that the timeframe of lifting capital controls will “to a great extent be determined by the speed of the winding-up of the failed banks”. 

The estates of Kaupthing, Landsbanki and Glitnir left the committees tasked with winding up their operations with some Ikr2552bn of assets, according to figures released by the central bank, in December 2013. Some 62.2% of these assets were held by foreign investors – at Kaupthing it was 73.5%, at Glitnir 64.2%, and at Landsbanki 49.1%.

“What we have heard so far is that a solution needs to preserve financial stability by ensuring that the settlement of the Icelandic krona assets has no negative impact on Iceland’s balance of payments position,” says Steinunn Gudbjartsdottir, chairwoman of the winding-up board of Glitnir. “We turned about 70% of the assets into cash and the majority is held outside Iceland – that is currency that has never entered the economy and therefore doesn’t have any effect on the balance of payments. We would like to distribute it.”

She adds that the Glitnir winding-up board sent its first proposal to the Icelandic central bank in November 2012 – and a revised one a year later – but it is still waiting for an answer. The plan requires the central bank to consult with the minister of finance as well as the prime minister before it can grant an exemption to pass the proposal, according to Ms Gudbjartsdottir.

Government involvement

The government plays an important role in the future of Iceland's successor banks. Not only does it hold the key to lifting capital controls, it also is a significant shareholder in the banking sector.

Landsbankinn is 97.9% state owned, after the government took over an additional 18.67% stake held by creditors in 2013. In return, Landsbankinn issued an Ikr92bn-equivalent foreign currency-denominated bond to its winding-up board – the second after Ikr260m-equivalent of foreign currency notes were issued in 2009. The remaining 2.1% stake in the bank is held by Landsbankinn itself and its employees.

Between 2015 and 2016, the Icelandic government aims to sell a 30% stake in Landsbankinn, according to the country's minister of finance and economic affairs, Bjarni Benediktsson. He intends to use the proceeds to pay down loans taken to recapitalise the country's banks following the crisis. This is necessary as the country’s debt burden is still heavy: while treasury debt was at 90% of GDP in 2011, it was expected to only have contracted to 78% by the end of 2014. The Icelandic treasury has the objective to bring debt down to below 60% by 2018, according to a presentation by Mr Benediktsson from September 23.

Yet, there is more scope for the government to recoup value. Apart from the Landsbankinn stake, the Icelandic state owns 13% of Arion Bank, with the remainder being held by Kaupthing. It also owns 5% of Íslandsbanki, with the remaining 95% being owned by the winding-up board of Glitnir, which accounts for around Ikr175bn of the total Ikr900bn of assets in insolvency proceedings with the Glitnir winding-up board.

Glitnir's foreign hope

Under Glitnir’s liquidation proposal to the central bank and the government, the Glitnir holding in Íslandsbanki would be sold to a foreign investor, according to Ms Gudbjartsdottir, as this would have less of a negative impact on the domestic currency. “There is interest in the bank from abroad,” she says. “But for investors to enter a small country such as Iceland they need to know that they are welcome.”

The proposal for the restructuring of Glitnir is supported by the informal creditors committee, which has the backing of about 70% of claim holders. The winding-up board is handling Ikr3200bn of initially filed claims, which after settlements of disputed claims has declined to Ikr2400. Not all claims have gone through the final evaluation stage yet but Ms Gudbjartsdottir does not expect to see the number change dramatically thereafter.

Still, should the government further postpone a final solution of the process, Glitnir’s winding up could yet get more complicated. “We are seeing extensive trading of claims in Glitnir,” says Ms Gudbjartsdottir. “It is extremely important not to make the creditors so impatient that they start selling their claims possibly to a different group of creditors with different views on how to solve things. So far we are still dealing with basically the same players in Glitnir.”

A brighter future

While the final outcomes of the banks’ winding-up proceedings remain unclear, the successor banks are working on building strong banks. “In our daily activities we are not concerned with [the winding-up proceedings] but are instead focusing on managing a good and credible bank, which will hopefully attract some reasonable future ownership,” says Mr Ólafsson at Arion Bank. “The winding-up process is interlinked with the government plans of lifting the capital controls, which is a complex challenge.”

He adds that it is clear that the Kaupthing estate and the government are looking to divest their stakes within a reasonable period of time.

Ms Einarsdóttir notes that Íslandsbanki has been focusing on its underlying business, “to ensure that we will be able to provide a proper return on equity when we have finished all the restructuring projects. We have managed to take the cost level down and have established a very strong platform for responsible future growth,” she says.

Whatever happens with the banks’ future ownership, Landsbankinn, Arion Bank and Íslandsbanki are rightly focused on their current operations rather than worrying about who their banks might end up with, especially as a timeframe for any final resolutions is still shrouded in uncertainty.


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