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The Icelandic Banking Saga : The ways to deal or not to deal with a systemic banking crisis

Every key feature of the Icelandic banking in the run-up to the 2008 year meltdown can be viewed as an emblem of the concept systemic banking crisis. The concept of a banking crisis is usually defined as “an event that shows significant signs of financial distress in the banking system and which is usually associated with significant bank runs, big losses in the banking system and bank liquidations.”[1]The detailed bank data, attained after the secrecy laws were being lifted after the crisis,[2]sheds light on five core problems that, in my estimate, portray the Icelandic crisis the best. These problems are unreliable deposit insurance system, fictional collaterals, inside dealing, the inadequacy of foreign reserves and supervision problems.     Due to banks’ central role in economic welfare, the main scope of the regulations and laws in the area of banking is to contribute to operational stability in financial corporations, increase the credibility of the system, protect the customers and increase the confidence of the public. Failure of one bank can lead to disastrous consequences for the whole economic system.[3]Probably one of the most critical situations is a scenario of a bank run. Bank runs are usually seen as depositors’ reaction to fear about the bank’s solvency.[4]They are usually characterized by a massive simultaneous withdrawal from banks that in many cases may lead to liquidity problems due to the liquidity mismatch of the banks.[5]A bank’s liquidity is defined as bank’s capacity to quickly react to a sudden withdrawal without having to sell off illiquid assets.[6]The phenomenon of bank runs has two very particular features: (1)they are associated with a tendency to “run” as soon as there is a signal of potential solvency problems, and (2) a tendency to create feedback.[7]The first feature implies that the depositors are most likely to withdraw their funds as soon as they see the slightest sign of potential insolvency. The second feature is a reaction to the first signal, when depositors, who not necessarily believe in signals, run because they do not want to be the last ones to withdraw their money. Lost confidence in one bank may eventually spread to other banks and result not just in a failure of the banks involved, but even in a systemic failure. In light of the aforesaid, many countries take different measures to prevent bank runs and financial panic. Among these measures is an establishment of deposit-guarantee schemes( DGS).[8]    The significant increase in deposits in Icelandic banks not only had the effect of transforming the financing of the Icelandic banking system but, as it will be discussed in the next chapters, eventually led to catastrophic consequences as about half of the deposits were deposited with the banks’ branches abroad and in foreign currency. This increase of deposits in foreign branches resulted in a substantial increase in the obligations of the Icelandic Depositors’ and Investors’ Guarantee Fund(TIF).[9]However, the TIF was unable to cope with such an increase. When depositors lost trust in Icelandic banks, and when there was no clear information whether the TIF covered the branches of Icelandic banks in the UK and Netherlands, a scenario of bank run was inevitable. Bank runs were seen not only in Iceland but also at the branches and subsidiaries of the Icelandic banks abroad. As stated above, a scenario of a bank run usually involves many depositors simultaneously withdrawing their deposits from a bank, which in its turn causes liquidity problems.[10]In the Icelandic case that is precisely what happened with bank accounts in Icelandic branches in the UK and Netherlands, since Icelandic banks were experiencing big liquidity problems in foreign currency.

Identiferoai:union.ndltd.org:UPSALLA1/oai:DiVA.org:uu-363982
Date January 2018
CreatorsBorodina, Kristina
PublisherUppsala universitet, Juridiska institutionen
Source SetsDiVA Archive at Upsalla University
LanguageEnglish
Detected LanguageEnglish
TypeStudent thesis, info:eu-repo/semantics/bachelorThesis, text
Formatapplication/pdf
Rightsinfo:eu-repo/semantics/openAccess

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