Sunday, August 7, 2011

An Analysis of the Icelandic Crisis

A look into the Iceland Crisis
This is a case-study about the Icelandic Banking Crisis. Essentially, this is about three banks which "Too Big to Fail", and ultimately "Too Big to Bail" as well. This is also the story about how Iceland's government intervened in order to minimize the spread of this crisis into the real Icelandic economy.

Basically, it shows us what can go wrong if we allow for sloppy micro-prudential banking regulation, ignore the need to coordinate across borders to regulate cross-border banking, and allow a country's banking sector to grow bigger than its economy. It was the perfect storm. Deregulation and free-trade sank the one of world's most soundly-managed economies (no national debt, top living standard in the world), in order to please shareholders in the short-term.

The study is an account of the Icelandic response to the 2008 financial crisis. Drawing on official and bank sources, an account is made of the methods used in bailing-out the major Icelandic banks, the response to the subsequent sovereign debt crisis, and the resulting post-crisis regulatory framework. Because 2008-2010 was a highly volatile time throughout the OECD which saw the failure of many banks across the world as the global financial system came under extreme stress, a closer look should be taken into Iceland’s policy responses to the crisis. Because of Iceland’s size in relation to its banks, the lessons drawn are highly relevant with respect to the “Too-Big-to-Fail” (TBTF) problem. Essentially, Iceland’s banks – which would have been TBTF in a larger country – were “Too-Big-to-Bail” Icelandic standards. Nevertheless, Iceland carried out a successful bailout from which smaller forms of the primary national banks emerged with the financial support of the financial stakeholders of the previous primary banks. As a result of Iceland’s actions, its banking sector is no longer too big to rescue. This paper has financial policy implications for both how small nations should handle large financial crises and for the financial crisis policy in the EU.
Icelandic Parliamentary Report on the Collapse of the Icelandic Banking sector
About the Author:
Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

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