A financial crisis has happened in Iceland which caused an economical recession in one of the smallest nations in Western Europe. A failure in three of the biggest banks in the country Glitnir , Landsbanki, and Kaupthing lead to economical crisis. The banking sector of the country was nationalized and integrated into a single functioning unit bank which was called Islandbank. The government decision had taken when the foreign debts in Icelandic banks reached more than 5 billion pounds. Although one of the banks had 40 branches in many different countries in the world, all of them are controlled by Financial Supervisory Authority.
The nationalizing of the three banks was decided after the three banks could not refinance the profits of the accumulated foreign debts which were exceeded 50 billion pounds and the deposit insurance was extremely high. The central bank reduced the minimum reserves requirement, and also it held high interest rates as well as increased the money supply to the market which lead to a high percentage of inflation, and the real value of the krona was overestimated, that caused for international creditors to distrust the three Icelandic banks. then the central bank could not repay the banks because its reserve was less than international debt which was 350.3 billion.
The impact of the crisis has caused many different problems not only inside Iceland but it's extended to beyond the country's borders. The major internal impact was increasing in unemployment rate, which was result of integrating the three banks together and minimizing their international operations. The other internal sector affected was imports, because the government restricted the dealings with foreign currencies which were an essential part for trading the important products and items.
Recommendation
The crisis was too heavy to hit a small country such as Iceland, the crisis impact will be long term, and the recovery process will take long time. We think the recovery cannot be done without the government, so the first important action was to suspend the international operations that dealt with Icelandic banks, although it caused inflation, it took part in minimizing the crisis impact. In order to solve the inflation problem the central bank should decrease the interest rate and that will encourage the households and companies to deposit more money.
Strengthening the liquidity is another important factor and this can be done by recapitalizing the banks, by attracting as much depositors to provide funds and capitals. Iceland can use the national resources to attract investors and especially in the fishing industry, and attracting many tourists for visiting the country. Also adapting the korona as the only currency inside Iceland, and use it for international trading such as pricing the exports of Iceland with korona, and that will stabilize the value of korona.
The government must have access to adequate amount of liquid assets to meet any conceivable redemption demand from depositors or to recapitalize banks that are insolvent as well as illiquid. The national banks have to denominate the liability such as deposits in to the national currency. The central bank has a potentially unlimited supply of domestic currency liquidity through its ability to issue legal tender at will.
They also must take a daring steps against increasing of the inflation, so the easily can offset the open market operations, and selling the securities whether they are public securities or private. If the securities are private, the government loses the principal and interest it would otherwise have received. So if the securities sold are government debts, then the government will repay the principal and interest to the private sector.
The taxes are very important and the government to overcome inflation problem and they should increase the taxes in order to minimize the spending, so the tax payers in Iceland must realize the importance of paying the taxes which can help in preventing inflation.
It's obvious that central bank of Iceland must borrow an extra foreign exchange. The best method for the central bank is to attempt to establish foreign currency credit lines, and also establishing overdraft facilities which was conducted in the three Nordic banks. The swap is a common dealings and arrangements conducted by the central banks in all around the world.
In December 2007 the Fed and SNB agreed to swap $4 million swap facility, and also a $20 billion swap facility between Fed and the ECB, so if we see Iceland did not took an advantage for swaps , because few foreign central banks would naturally wish to take a significant long position in the Icelandic króna. However, the problem of the global contagion fallout from an Icelandic bank failure is likely to be quite Persuasive and the ECB, the Bank of England and the Fed may be willing counterparties.
However the government of Iceland faced some difficulties in borrowing money from foreign countries, and that is due to the credit rating of Iceland after the crisis.
So we will conclude our recommendation by emphasizing on four major points, the first one is that financial supervision must be more effective if it was consolidated inside central bank of Iceland, so it's good reason to have prudential supervision in central bank.
Secondly the central bank of Iceland should change scale that it uses for its inflation target to minimize the influence of housing price fluctuation, so that means CB should target on inflation measures that are mostly comprised of prices that are sticky, and so exclude asset prices such as housing.
Thirdly Iceland's commercial banks should be encouraged and should also see that it is in their best interest to show more information about their activities. That will increase the confidence among the individuals and customers and bad rumors will be eliminated.
Finally the government should implement a formal fiscal policy rule in order to dampen the Icelandic business cycle to support monetary policy better.
Finally the government must utilize the fiscal policy to reduce the cycle of Icelandic business to effectively support the policy of monetary.
