Iceland The Country That Become A Hedge Fund Finance Essay - Free Essay Example

Sample details Pages: 11 Words: 3367 Downloads: 3 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? The report of Iceland: The Country That Become a Hedge Fund is written by Peter Gumbel, a Europe editor of Fortune Magazine. This report is basically explained the development of Iceland going bankruptcy. The financial crisis of Iceland is happened at the end of year 2008 until now. This crisis comprises the collapse of all of the countrys main commercial banks which are Glitnir, Landsbanki, and Kaupthing due to their difficulties in refinancing their short-term debt and a run on deposit in the United Kingdom. In late September 2008, there was news about Glitnir bank would be taken over, followed by Lansbanki and Kaupthing was passed to receivers appointed by Financial Supervisory Authority (FME) as well. The assets of the three banks taken under control of the FME totaled 14.437 trillion kronur at the end of second quarter 2008. Icelands external debt was 9.553 trillion kronur, equaled to 50 billion pounds, more than 80% of which was detained by the banking sector. Don’t waste time! Our writers will create an original "Iceland The Country That Become A Hedge Fund Finance Essay" essay for you Create order This financial crisis has had serious outcomes to the Icelandic economy. The national currency, Kronur had fallen stridently in value, foreign currency transactions were nearly suspended for weeks. Besides, the market capitalization of the Iceland stock exchange has plunged by more than 90%. Due to the crisis, Iceland is currently suffering a severe economic recession; the nations gross domestic product (GDP) reduced by 5.5% in real terms in the first months of 2009. Although, the full cost of the crisis cannot yet be revealed, it already exceeds 75% of the countrys 2007 GDP. Background of the Central Bank Chairman of Iceland, David Oddsson David Oddsson was born on 17 January 1948 at Reykjavik, Iceland. He is an Icelandic politician and the longest-serving Prime Minister of Iceland. He was holding office from 1991 to 2004. He also was a Foreign Minister from 2004 to 2005. In the past, he was Mayor of Reykjavk from 1982 to 1991, and he leaded the board of governors of the Central Bank of Iceland from 2005 to 2009. The collapse of Icelands banking system led to verbal demands for his resignation both by members of the Icelandic public and by Icelandic Prime Minister Johanna Siguroardottir. This resulted in him being replaced as head of the Central Bank in 2009. In September 2009 he was hired as the editor of Morgunbladid, one of Icelands largest newspapers. Background of Glitnir Bank Before 1930, Glitnir was first named as Islandsbanki. Islandsbanki was founded at1904, to provide financing service mainly for the fisheries sector and the countrys emerging industries. It functioned until 1930, when its activities were taken over by Utvegsbanki, the Fisheries Bank of Iceland. 60 years later, three smaller banks, Idnadarbanki slands (the Industrial Bank of Iceland), Verzlunarbanki Islands (the Iceland Bank of Commerce) and Alpydubankinn (the Union Bank) were combined with Utvegsbanki to form a new Islandsbanki, which later became Glitnir. Now the name Islandsbanki will be adopted once more to replace Glitnir after the collapse of the financial system. The decision to restore the name Islandsbanki was prompted in part by proposals made by a huge number of the banks customers in recent months. Islandsbanki is a valuable and well-known brand. The name has a long tradition behind it and shows the banks new strategy emphasizing principally its home environment and serving Icelandic companies and families. Background of Kaupthing Bank Kaupthing Bank was an international Icelandic bank, headquartered in Reykjavk, Iceland. It was structured by the merger of Kaupthing and Bunadarbanki Islands in 2003 and is the largest bank in Iceland. Kaupthing Bank formerly operated in thirteen countries; including all the Nordic countries, the Netherlands, Belgium, Luxembourg, Switzerland, the United Kingdom and the United States. It is the seventh largest bank in the Nordic countries in terms of market capitalization. On 9 October 2008, the Icelandic Financial Supervisory Authority took control of the bank after a major banking and financial crisis in Iceland. So far, it has not been declared bankrupt, although it has obtained a moratorium on payments from the District Court of Reykjavik and has been suspended from trading in the Iceland Stock Exchange. On November 20, 2009, New Kaupthing, the name given to the spin-off of the banks Icelandic based operations, changed its name to Arion Banki. Non-Icelandic assets are still held within the bank which continues to be called Kaupthing, as of August, 2010. Background of Landsbanki Bank Landsbanki is normally known as Landsbankinn in Iceland. It was international Icelandic bank. On October 7, 2008, the Icelandic Financial Supervisory Authority took control of Landsbanki. Since its establishment in 1885 (commenced operations in 1886) Landsbanki has been influential in the economic development of business and industry in Iceland. Landsbanki was the central bank of Iceland from 1927 until 1961. At the time, this interest was principally directed towards note issuance rather than monetary policy. It was later replaced in this capability by the Central Bank of Iceland at the behest of the Althing. Landsbanki currently has 40 branches and sub-branches all over Iceland, plus a wide-ranging network of international correspondent banks. Landsbanki and its subsidiaries have offices operating in 15 different countries, including the major financial centre of Europe, and North American representation in New York, Winnipeg and Halifax. 2.0 Discussion Part The Main Causes The main causes of the crises of Iceland started in 2001 when the banks deregulated the Iceland. Meanwhile, this makes easier for the banks to upload debts while foreign companies were accumulated or making profit. However, the crises has unable to refinance their debts. The three major banks hold foreign debt excess ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬50 billion, compared with Icelands gross domestic product which is ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬8.5 billion. In early March 2008 for deposit insurance in Landsbanki and Kaupthing was higher (6-8 ½% of the sum deposited) comparing to European banks. For the domestic market, the Iceland banks financed their expansion with loans on the interbank lending market and about 60% depositing outside Iceland, (which also becoming external debt). Meanwhile, the central bank reduced the percentage of assets of the bank required to deposit. One the other side, Households took on a large amount of debt equivalent to 213% of disposable income, which leads to inflation. However, This inflation was increased the practice of the Central Bank of Iceland by issuing liquidity loans to banks on the basis of newly-issued, which were uncovered bonds, by printing money on demand. In response of raising the prices to 14% within twelve month to September 2008, compared with the mission of 2.5%, therefore, the central bank of Iceland held high interest rates 15.5%. For example in compared with 5.5% in United Kingdom and 4% in Eurozone, has encouraged overseas countries which are the investors to hold deposits in Icelandic Kronur, leading to monetary inflation. Meanwhile, the Icelandic money supply (M3) increased 56.5% in the twelve months to September 2008, compared to 5.0% GDP growth. This situation was very bad in the economic because the investors was overestimating the exactly value of the currency in Krona. This resulted to become difficult to roll over their loans in the interbank market, on the other hand, the creditors also was insisted on repayment while no other banks were willing to make fresh loans, whereby in such situation arises the bank have to ask a loan from the central bank as the lender of the last resort. However, the Icelandic government and central bank of Island could not guarantee the repayment of the banks debt which results to collapse of the banks. Meanwhile, the reserves of the central bank of Iceland has stood up 374.8 billion Kronur at the end of September 2008, compared with the 350.3 billion Kronur of short term international debt in the Icelandic banking sector, while 6.5 billion(1,250 billion Kronur) of retail deposits in the UK. The Main Effects Financial crisis of Iceland has mainly effected into the The currency of the country Banks of the country Stock market 1. The currency of Iceland The Icelandic Krone had resulted to declined more than 35% a gains euro from January to September 2008. While the inflation of consumer price was running at 14% and the interest rate was increasing to 15.5% this result shows us that the currency dealing with high inflation. Meanwhile, lets to take one example of the trading of Icelandic Krone, on Wednesday the Icelandic was trading 340 into euro , this is because when the FMEs decided to takeover Icelandic banks , which has resulted to loss all Krone trade (clearing houses ) However, on 15 October the central bank of Iceland launched a temporary system of the daily auction currency, which can be determined the value of Krona by checking the supply and demand of this auction. Moreover the first auction was sold ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬25 million for the rate 150 Kronur against euro. Flowed by the last auction which was held on 3 December, therefore the Krona climber 153 against euro, up to 22% increased for the last currency auction rate. (This graph shows declining of the Icelandic krna against the euro) 2. Banks of Iceland The crises has mainly effected to collapse the major commercial banks . this will be the largest suffered by any country in the history. Moreover. The Glitnir is one of the international Icelandic bank, which has being effected the financial crises. On 29 September, The Icelandic financial supervisory authority (FME) has announced that the Glitnir will be nationalized with the purchase of 75% stake of ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬600 million. This is because the government is not willing to hold ownership of the bank for a long period ,however, within weeks the bank has turned out of debt US s750 million due to mature on 15 October. Flowed by on 6 October, when a number of credit facilities owned by the private interbank facilities to Icelandic banks were suddenly shut down. The prime minister Gier Haarde was mention that there will be a package of a new regulatory measures will be passed to the Althing (is the national parliament of Iceland). Meanwhile, the parliament cooperating with the opposition parties and the power FME which they attend to take over the banks without nationalizing them, was guaranteed in separate measure, retail deposit in Iceland branches. After they make that decision On 9 October FME placed the Kaupthing bank into receivership flowed by the resignation of the entire board of directors. The Kaupthing bank mention that it was a technical default on its loan agreement this is because when UK subsidiary had been placed into administration. 3. Stock Market The financial crises has mainly effected the stock market whereby many shares collapse. Lets to take one example, on 6-13 October FME was cancelled OMX Nordic include six financial companies on the Iceland exchange , this is because there was unusual market condition, the shares was falling 30% since the beginning of the month. When it was reopened the main index, the OMZ Iceland 15, at 678.4 which has corresponds to a plunge about 77% compared with 3,004.6 before the maturity. Moreover, On 9 December, the two financial service companies which are Straummber-Buroaras and Eixsts ,there accound was 12.04% of the OMX Iceland 15. This shows the value of shares of the two companies are dropped sharply. Meanwhile the index was close at 394.88, down by 40.17% on the day. On the other hand, SPRON and Kaupthing was remain suspended at the price of ISK 1.90 and ISK 694.00 respectively. During Iceland financial crises there were four credit rating agencies which controls sovereign debts are lowered their rating and turned their future rating change negatively. However, the government was healthy balance whereby the sovereign debt was 29%, and a budget surplus 5.5% of GDP, while the debt is now 90% of GDP with a budget deficit. Furthermore, the value of foreign currency bonds remains in $600 million in 2009 and foreign currency debt was $215 million. After in such economic bubble, the government tried to get assistance in many countries include Moscow, Russian, Denmark and Norway and many other countries, but fortunately they got respond from Norway, Sweden, Findland to loan ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬2.1 billion and another $2.5bn of loans and currency swaps. flowed by Denmark, Germany, Netherland and united Kingdom loan of $ 6.3 bn . (The value of the OMX Iceland 15 from January 1998 to October 2008) The effect of the crises Within Iceland The financial crises in Iceland has severely effected in the Iceland business and citizens in the country. For example , the replacement of the old bank Laandsbanki to the Landsbanki losses 300 employees , this is because of radical restriction of the organization to minimize international operations of the bank. Similar jobs loses happened in Kaupthing and Glitnir, the job losses are estimated with the 2,136 registered for un employed while only 495 had got vacancies at the end of August 2008 There were many other company effected in this situation include the privates Sterling Airlines company declared bankruptcy on 29 October 2008. While the national airline Iceland air has also noticed significant losses for flights. However, for other business such as importers it was very hard hit, this is because the government restricted the foreign currency even the essential product such as food, medicine and oil. However the ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬400 million loan from Norway and central bank of Denmark was insufficient to pay for months imports. This results that the Icelands GDP shrink by as much as 10% , putting Iceland some measures in an economic depression. And the inflation was expecting to climb as higher as 75% by the end of this year. Moreover, In November 2008 the financial crises was deteriorating by resulting to tripled the unemployment with over 7,000 registered in the jobseekers, compared to 2136 at the end of the August 2008. Meanwhile, as 80% of household debt is indexed while another 13% denominated in foreign currencies, which resulted to become costly for the debt repayment. Outside Iceland The financial crises was not only based on Iceland country but also there was more than 100 outsides business effected. For example UK in the local authorities, specially Kent Country bank invested Icelandic banks more than 840 million cash . This is because they were working and getting advice under the government, whereby giving direction to invest their money across international banks and many other national banks regarding of spreading the risk.The most investment was paid in police service and fire authorities and even the audit commission. The investors was hoping that one third of their money will get back rapidly, corresponding to the UK subsidiaries of the liquid asset. And other assets liquidation include loans and offices thinking that it will take longer time However in Novermber 2008 the cost of the deposit insurance in UK authoraties was not very clear, but there was some depositors paid include UK treasury 600 million, followed by the transferring the deposit to FSCS (Financial services compensation scheme) 3 billion into the Heritable Bank and Kaupthing Singer friendlander to ING direct. Conclusion 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 its extended to beyond the countrys 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. Its 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 krna. 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 its 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 Icelands 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.