The 2008 financial crisis cast a shadow on Iceland’s banking sector, causing a significant shift in the nation’s regulatory landscape. International bank creditors, understandably concerned about potential losses in the event of bank failure, need to be well-informed of the various aspects surrounding Iceland’s banking regulations and processes. Iceland’s banking laws are primarily governed by the Financial Undertakings Act No. 161/2002, the Act on Official Supervision of Financial Activities No. 87/1998, and the Act on the Depositors’ and Investors’ Guarantee Fund No. 98/1999. These laws regulate the establishment, operation, and winding up of financial institutions, including banks, and provide the framework for dealing with bank failures.
As a result of their involvement in the 2008 financial crisis, several Icelandic banks and credit institutions faced closure or significant penalties. The three largest banks – Kaupthing Bank, Glitnir Bank, and Landsbanki – were the primary institutions that collapsed during this period. Forced closures resulted from the banks’ unsustainable business models and inability to meet their obligations during the 2008 financial crisis. Monetary penalties were imposed on the banks’ executives for their fraudulent actions, market manipulations, and breach of fiduciary duties, which contributed to the banks’ collapse and had severe repercussions on the Icelandic economy.
Bank failure in Iceland is defined as a situation in which a bank is unable to meet its obligations to its creditors or has its license withdrawn by the Financial Supervisory Authority (FSA). Additionally, a bank may be considered as failing if it is deemed likely to incur losses that would deplete its capital base or render it insolvent. The determination of bank failure in Iceland is carried out by the FSA, which is responsible for monitoring and supervising the activities of financial institutions. The FSA assesses banks’ financial conditions, capital adequacy, risk management practices, and compliance with regulations. It has the authority to conclude that a bank is failing or likely to fail and to initiate appropriate actions to safeguard the interests of depositors and creditors. Bank failure can be concluded based on factors such as insolvency, the bank’s inability to pay its obligations when due, or the withdrawal of the bank’s operating license by the FSA. The FSA’s mandate in this regard is derived from the Act on Official Supervision of Financial Activities No. 87/1998.
Once a bank failure is determined, the FSA initiates the resolution process. The most common reasons for bank failure in Iceland include excessive risk-taking, poor corporate governance, inadequate capital buffers, and external shocks, such as the 2008 financial crisis.
Bank supervision in Iceland aims to preserve the critical functions of banks and ensure their continuation in times of financial distress. This is achieved through regular inspections, stress tests, and the development of resolution plans that outline the steps to be taken in the event of a bank failure. The FSA works closely with the Resolution Committee, established under the Financial Undertakings Act, to implement these plans and protect the stability of the financial system.
The Resolution Committee is the designated resolution authority in Iceland, responsible for handling the resolution of failed banks. Its mandate includes determining the appropriate resolution tools, ensuring the continuity of critical functions, and minimizing the impact on taxpayers and the financial system.
Iceland offers a range of resolution tools for dealing with failed banks, such as the sale of the business, the establishment of a bridge bank, or asset separation. These measures aim to maintain the bank’s critical functions, protect the interests of depositors and creditors, and ensure an efficient resolution process.
Icelandic law provides a safety net for depositors and creditors in the event of a bank failure. The Depositors’ and Investors’ Guarantee Fund (DIGF) was established under the Act on the Depositors’ and Investors’ Guarantee Fund No. 98/1999 to protect depositors and compensate them up to a specified limit in case of a bank failure. Creditors, including international bank creditors, can also benefit from the priority ranking of claims in the resolution process, ensuring the orderly distribution of the failed bank’s assets.
To ensure that non-viable firms exit the market in an orderly manner, Iceland’s regulatory framework empowers the FSA and the Resolution Committee to intervene at an early stage, identify potential risks, and take necessary actions to prevent systemic damage. This approach minimizes the risk of disorderly liquidation and the associated negative consequences on the financial system and the economy.
Bank liquidation rules in Iceland are stipulated under the Financial Undertakings Act No. 161/2002. If a bank is deemed non-viable and the resolution process is deemed inappropriate or unsuccessful, the bank can be subject to liquidation. In this case, a winding-up board is appointed to oversee the liquidation process, including the sale of assets, the settlement of claims, and the distribution of the proceeds to the bank’s creditors.
Iceland’s banking laws and regulations have evolved significantly since the 2008 financial crisis, with a stronger emphasis on supervision, resolution planning, and the protection of depositors and creditors. International bank creditors concerned about potential losses in the event of a bank failure in Iceland should familiarize themselves with the country’s legal framework, resolution processes, and the steps to protect their interests. By staying informed and proactive, international bank creditors can better navigate the complex landscape of Iceland’s bank failure and safeguard their position.