Gylfi Zoega analysis: Iceland and the hazards of internet accounts

Gylfi ZoegaAn analysis by Gylfi Zoega, professor of economics at Birkbeck College, UK and the University of Iceland:

Two years ago, the Icelandic bank Landsbanki, which had nothing to do with the government, introduced internet accounts in Britain under the name Icesave that offered savers a higher rate of interest than local banks were willing to pay. Later Icesave entered The Netherlands and there were plans for further extensions.

The law in the European Economic Area allows banks to set up such accounts outside their home country.
As a result of the bank’s failure one week ago, more than 100 local councils, charities, universities, police authorities and fire services in Britain stand to lose up to £1bn in these savings accounts. While Alistair Darling, chancellor of the exchequer, has guaranteed personal deposits, the British government has not offered such guarantees to these organisations. The possible loss of money by these organisations would be a tragedy.

In spite of the apparent clash between the governments of Iceland and the UK, Iceland’s responsibilities are clear. According to Icelandic law, Iceland is liable to pay the first £16,317 (€20,887) to each account holder from its own deposit guarantee scheme. The rest, up to £50,000, is covered by the financial services compensation scheme in the UK.

The setting up of the Icesave accounts by Landsbanki is a manifestation of a market failure. The bank used the deposits to strengthen its liquidity, while at the same time imposing a very significant risk on the population of Iceland due to the size difference between the two nations. The number of Icesave account holders in the UK is equal to the entire population of Iceland (300,000) and this does not include deposits at the biggest Icelandic bank, Kaupthing (Kaupthing Edge), or internet deposits in other European countries! If the bank had survived, its owners would have reaped the rewards, while its failure last week imposes a burden on Iceland’s current and future generations. This is moral hazard at its worst.

The population of Iceland has suffered immensely from the failure of its banks; pension funds have been hit heavily; the country’s money market funds have been wiped out, thus also the savings of a very large number of people. Thousands of workers are losing their jobs, the foreign exchange markets have collapsed and the country is facing the very real possibility of not having adequate food and fuel in coming weeks.
During this period of crisis the British government decided to attack Icelandic businesses in Britain to protect the interests of Icesave customers by invoking anti-terrorism laws rather than contacting Icelandic authorities to seek clarification and collaboration. This resulted in the loss of assets which makes it more difficult to compensate Icesave account holders fully. This act was followed by formal negotiations in which the British representatives are seeking to make the Icelandic nation repay Icesave deposits beyond the deposit insurance scheme.

The Financial Services Authority could have warned about Icesave, limited its scope or shut it down altogether. They did not do any of these things. The reason that the British government is so enraged is that the government itself, in the form of the local authorities, invested hundreds of millions of pound in Icelandic banks.

The people of Iceland should not have to suffer unnecessarily from the consequences of decisions made by the billionaire owners of Landsbanki nor the rage of the British government.

Copyright The Financial Times Limited 2008

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