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Five Primary Reasons for the Icelandic Financial Crisis

Five Primary Reasons for the Icelandic Financial Crisis
"""The effects of the Icelandic financial crisis have been, to say the least, far-reaching. Banks were hit the hardest, but industries such as real estate and aviation also felt the cascading effect of the financial crisis. Numerous businesses declared bankruptcy. Even the Krona, Iceland's national currency, has taken a significant hit, and as a consequence, Iceland's economy is in a complete tailspin. Before we examine the causes of the Icelandic financial crisis, here are a few cascading effects to consider: During the first six months of 2009, the Gross Domestic Product of Iceland fell by 5.5%. The total debt of Iceland is roughly 9,500,000,000,000,000 Kronur. Compare this to the estimated Icelandic GDP of 1,9 Trillion Kronur, and you can see that Iceland is buried in debt.

Here are the reasons for the Icelandic economic crisis.

Incapable banks to refinance their obligations.

When the financial industry in Iceland was deregularized in 2001, banks began to upload debts. This occurred at a time when foreign businesses were accumulating. By 2008, three prominent Icelandic institutions had accumulated debts totaling 50 billion Euros. Compare this to Ireland's GDP of 1,9 Billion Euros, and it becomes apparent that there is a disparity.

Inflation due to development

The majority of Iceland's expansion activities in the new economy were financed through the interbank lending market. External debt played an important role in financing the expansion as well. The fact that household obligations were approximately 200 percent of the average family's disposable income drove up the price of essential goods. This resulted in inflation, which was bolstered by the Central Bank of Island issuing loans to banks against uncovered bonds.

Miscalculation of the Kronur

Up until September 2008, prices increased by 14%, representing the steepest price increase in Icelandic history. The Central Bank of Island attempted to compensate for this by charging a 15% interest rate. These rates were unheard of in European nations, where the maximum interest rate is 5 percent. Such a high interest rate resulted in a number of countries investing in Iceland. This resulted in a gross overvaluation of the Kronur, indicating that a bubble was just about to explode.

Incomplete action on bank loans has resulted in a free-fall for banks.

The majority of Icelandic institutions refused to make new loans. As their creditors demanded repayment, it was also challenging for the larger banks to turn over their loans on the interbank market. In such a difficult circumstance, banks approach the largest bank, which they did by contacting the Icelandic Central Bank. The problem was that the Central Bank of Iceland refused to accept ownership, and the Icelandic government could not guarantee repayment of debts because, institutionally, the Central Bank of Iceland is significantly larger than the Icelandic government. All of this resulted in a precipitous decline for banks, as credit was simply not readily available.

Icesave, a subsidiary of Landsbanki, exacerbates the problem.

Icesave should have technically functioned as an independent entity, but it did not. It operated under the name Landsbanki and was dependent upon it for emergency funds. Consequently, Icesave could not rely on Bank of England. Plans to alter this situation were formulated, but they never materialized. The Icelandic financial crisis was a systemic malady, but only affected the banking sector, unlike the subprime crisis, which involved the real estate and finance sectors. However, for a small economy like Iceland, a hit to the financial sector implies a blow to the economy at the worst possible time.

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"Five Primary Reasons for the Icelandic Financial Crisis" was written by Mary under the Finance / Wealth category. It has been read 180 times and generated 1 comments. The article was created on and updated on 02 June 2023.
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