Bringing Down the Banking System: Lessons from Iceland
By an investigator on the Special Investigation Commission; connected lending and cross-ownership.
Summary
Johnsen served as a senior researcher on Iceland's Special Investigation Commission, the parliamentary inquiry into the 2008 collapse of the country's three major banks, and wrote this account drawing on the Commission's evidence.
The scale is the starting point. Iceland's banks grew from a combined balance sheet roughly equal to national output in 2003 to nearly ten times it by 2008, funded substantially in foreign wholesale markets and in foreign currency, against a central bank with reserves that could not possibly support them. When wholesale funding closed the banks could not be rescued, because the state's capacity was a fraction of their liabilities.
The mechanisms Johnsen documents are specific. The banks lent enormous sums to their own largest shareholders and to companies connected to them, which meant the equity supporting the balance sheet had been funded by the banks themselves. They lent to parties buying their own shares, which produced apparent capital that would evaporate if the share price fell. Cross-ownership among the banks and their major clients concentrated risk that the disclosed accounts did not reveal. The banks acquired foreign deposits through internet accounts, particularly Icesave in Britain and the Netherlands, which created liabilities to foreign depositors that Iceland could not honour and which became a diplomatic crisis.
On governance and supervision, she documents a regulator with a handful of staff overseeing a banking system many times national output, a central bank that continued to treat the banks as sound, and a political system with close connections to the bank owners.
The book is written from primary evidence and is one of the few accounts of a financial crisis produced by an investigator with access to the full record. It is specific to a very small country, which is both what makes the case extreme and what limits the direct transferability.
Key takeaways 7
- Icelandic bank balance sheets grew to nearly ten times national output, which made state rescue arithmetically impossible.
- The banks lent to their own largest shareholders, so the equity supporting the balance sheet had been funded by the banks themselves.
- Lending to parties buying the bank's own shares produces capital that disappears exactly when it is needed.
- Cross-ownership among the banks and their largest clients concentrated risk that the published accounts did not reveal.
- Foreign internet deposit accounts created liabilities in foreign currency that the home state could not guarantee.
- A regulator with a handful of staff cannot supervise a banking system many times the size of the national economy.
- Rapid balance sheet growth funded in foreign currency wholesale markets is the specific pattern that made the collapse unavoidable.
Who should read it
Regulators, risk managers and investors who want an investigator's account of how a banking system grew beyond any possibility of rescue.
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Where it sits in the reference 2
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