The Icelandic Regulatory Responses to the Financial Crisis

Abstract

Iceland was hit hard by the financial crisis in 2008, especially by the spill-over effects of its banking failure when all of its three major banks collapsed. This article examines the Icelandic regulatory response to the crisis. The Icelandic case is special as the banks were not only too big to fail but also too big to rescue. Thus, legislation dealt with the failure of the banks and the aftermath of the crisis. First, the most important legislation was the Emergency Act that provided the Financial Supervisory Authority (FME) with emergency authority over banks in danger of becoming insolvent. The role of banks is integral to any economy. In order to ensure normal banking services and the safety of deposits in Iceland, three new banks fully owned by the Icelandic government were established on the basis of the Emergency Act. The most controversial provision of the Emergency Act granted depositors' claims priority over other unsecured claims in the winding up of the collapsed banks. Now the EFTA Surveillance Authority has concluded that this did not constitute a breach of the EEA Agreement. The Emergency Act made necessary amendments to the Act on Financial Undertakings concerning the reorganisation and winding up of financial undertakings. Second, a Special Investigation Commission was established by law. To enable a search for the truth, the legislation was far-reaching. The primary role of the Commission was to seek the truth. The report of the Commission discloses information that otherwise would not have been disclosed because of bank secrecy laws and sheds a unique light on the practices of the banks. Third, it was considered important that the law would be enforced by all necessary means. Thus, the temporary position of Special Prosecutor was established by law. Fourth, cross-border banking in the EU/EEA is examined in the light of the so-called Icesave dispute between Iceland on the one hand and the UK and the Netherlands on the other. It sheds a light on some of the major flaws of cross-border banking in the EU/EEA already known and criticised long before the crisis. When the Icelandic banks collapsed, the government of Iceland declared that all deposits in domestic banks and branches were guaranteed but not those in foreign branches. This gave rise to the question of whether Iceland could be held liable on the basis of the EU Deposit Guarantee Directive or because of discrimination of depositors based on nationality. In any case, the financial crisis has shown that there is a gap between law and reality. The conclusion of this article is that it is questionable whether the potential economic benefits of full integration in the field of cross-border banking outweigh the dangers and risks that come with it. If not, the price of full integration may be too high.