Credit Crisis Woes Iceland's Financial Woes Could Push It Closer to EU

Iceland is in trouble. With credit markets frozen, the country is looking for a way to prop up its debt-laden banking system. The currency is already tanking as are the stocks of some of its leading banks. Could EU membership be on the horizon?

Reykjavik and the rest of Iceland is looking for a saviour.

Reykjavik and the rest of Iceland is looking for a saviour.

If one is looking for a barometer by which to measure the rapidly expanding global financial crisis, Iceland might be the best place to look. After years of lending huge amounts of money overseas, Iceland's banks have now been slammed as credit dries up and the value of the country's currency, the krona, plunges. Even worse, many are concerned the government in Reykjavik might not be able to afford a bailout of the country's wobbling financial institutions.

The result was a weekend of emergency government talks in the nation of 300,000 which dragged into Monday morning without a clear solution, though an announcement is expected later in the day. According to a report in the Times of London, the situation has become so dire that the government in Reykjavik has even begun asking for financial help from the United States and from Scandinavian countries. According to the Telegraph, the Icelandic government has asked the European Central Bank for a loan of £400 million (€514 million).

Iceland's Prime Minister Geir Haarde announced on Sunday evening that a number of the country's largest banks have agreed to begin repatriating funds by selling off foreign holdings. The move is aimed at injecting much-needed cash into the country's banking system, which is struggling to find enough credit for day-to-day operations. Icelandic media have also reported that two of the country's biggest banks, Kaupthing and Landsbanki, may merge. Reykjavik spent €600 million to partially nationalize another large financial institution, Glitnir Bank, last week.

Labor Union Calls for EU Membership

The country's Pension Fund Association -- whose assets totalled some €13.4 billion ($18.4 billion) at the end of 2007, much of it held overseas -- has also expressed its readiness to sell many of its foreign assets to bring home liquidity. According to news reports, though, Iceland's trade unions are demanding that Reykjavik apply to join the European Union and move to adopt the euro in return for reducing the pension fund's overseas assets. "We should aim for EU membership and the adoption of the euro as soon as possible," a labor union memo published by a local Icelandic paper stated.

But even as Haarde expressed confidence that his government's plan to generate liquidity would be enough, the markets on Monday weren't buying it. The Icelandic Stock Exchange ceased the trading in shares of the country's six major financial institutions, saying trading would resume once the final details of any solution were announced. Share prices for SPRON, one of the six leading banks, dropped 17.4 percent before trading was suspended, though drops at other banks were not nearly as dramatic. Landesbanki stock prices even climbed slightly on Monday morning. The same day, leading credit ratings agencies downgraded the country's four biggest banks.

Even as the country's political and financial leaders promised an agreement on Monday, it isn't entirely clear exactly what can be done for Iceland's financial system. In recent boom years, Iceland's banks went abroad to find cheap credit and invested heavily in the United Kingdom, Denmark and elsewhere. The total assets of Kaupthing Bank, Landsbanki and Glitnir -- the country's three biggest -- were 14.4 trillion kroner ($128 billion) at the end of June, according to the Wall Street Journal. The country's gross domestic product in 2007 was just 1.3 trillion kroner.

The global credit crisis, though, has suddenly made it difficult to find any cash to borrow at all, essentially pulling the rug out from under Iceland's debt-funded economy. In an address on Thursday, Prime Minister Haarde warned his countrymen of "the inevitable cut in living standards" that the country is facing. One of the most immediate results of the frozen credit market has been the ongoing devaluation of the krona. The currency has lost 30 percent of its value against the dollar in the last 30 days and inflation has soared to 14 percent. Iceland's currency lost 10 percent against the euro last week alone.

In short, with the country's economy dominated by the banking sector, Reykjavik has little choice but to find a way to shore up Iceland's financial system. But even as the country's banks are too big to let fail, they might be too big to save should global credit markets fail to loosen up rapidly.

cgh -- with wire reports


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