The downfall of the banks

Glitnir Bank was one of the first Icelandic Banks to experience difficulty in 2008. With a significant amount of debt securities maturing in late 2008, the bank tried to issue more debt. However, the market was unresponsive to a new offering. They also tried selling off some of its assets but again this was not adequate. 

Furthermore, the bank was also denied two loan extensions from the Bayerische Landesbank.

Eventually the government decided to use 600 million Krona to purchase 75% shares of Glitnir Bank since they had 1.4 billion outstanding that was to be due in just a few month’s time in 2008, (Ivester, 2010). Unfortunately, this also sent a bad signal to the financial markets and depositors in Landsbanki and Kaupthing banks began to lose faith in the banking system and withdraw their monies. Icelandic banks began to experience a deposit drain.

Icelandic Banking systems did not include a lender of last resort since the central bank of Iceland did not provide this facility. Additionally, the Icelandic Krona had depreciated so low that the central bank could not have just printed more currency to increase foreign capital reserves. These would have been used to lend to the troubled banks to replay obligations that was becoming due, (Ivester, 2010).

What Iceland did that was different

Unlike most European countries that were in crisis back in 2008, Iceland has tackled its rehabilitation process quite differently and in a very unusual and shocking manner. Iceland allowed its three major banks; Kaupthing , Landsbankinn and Glitnir Banks to fail  and default on their debt instead of trying to bail them out. However, they did ensure that local depositors were compensated and assisted with debt relief for struggling small businesses and home owners. From the video below we can see exactly what they did. 

Olafur Ragnar Grimsson, Iceland's president explains it in this short informative interview with Steven Cole of Al Jeezera.

As explained in the clip and above concerning the compensation of domestic depositors by the Government, this facility was not extended to foreign accounts in the United Kingdom and the Netherlands. These accounts at the foreign subsidiaries were known as Icesave acounts which were with the Landsbanki Bank. When the bank in question completely failed, approximately 6.9 billion euros were lost in these foreign accounts at the time.

What happened in Iceland shocked the world just as the collapse of Lehman Brothers did. For a country with such high standard of living and high GDP per capita to suddenly collapse, was unheard of. Allowing the banks to fail and defaulting on their debt obligations added to the sinking of this ship. Popular media personnel and artist began to describe Iceland as Icelantis and can be seen depicted below.

Source: www.toonpool.com