Exchange rate indexation of loans is illegal in Iceland and this also applies to domestic loans, according to a new court ruling that could have major consequences.
Exchange rate indexation of loans means that the total amount owed in Icelandic kronur varies according to its exchange rate against the currencies in which the loan was issued. Such loans were aggressively promoted by the Icelandic banks in previous years and have now left many diligent car and home owners with bigger debts than the original amount – despite paying their bills every month.
Now the Reykjavik District Court has ruled that such loans are illegal – a ruling which directly contradicts a ruling in the same court in December, RUV reported.
According to the legal precedent, courts may now start ordering that exchange rate indexed loans be turned into regular inflation indexed loans denominated in Icelandic kronur.
The whole issue rests on a slight loophole, as exchange rate indexation is indeed illegal; but it is not illegal to lend in foreign currencies and then secure repayments in those currencies or in Icelandic kronur. But it is illegal to lend in Icelandic kronur and secure repayments pegged to the exchange rate of foreign currencies.
Customers taking out ‘foreign currency loans’ in Icelandic banks to buy homes and cars in Iceland were given their money in Icelandic kronur. The court has now ruled that this was illegal.
[…] Court rules in favour of Icelandic foreign loan holders […]
[…] Court rules in favour of Icelandic foreign loan holders […]
@Bjarni,
It is a bit off topic but I can tell you a story which I heard from a cousin who worked as a car-seler.
He was really good at this because he was able to reckognize the wishes of his customers and he always made them feel as ‘ special’ people who needed ‘ special ‘ cars.
After another succesful sale he was sitting behind his desk with the customer in order to arrange the payment.
His employer (Opel) had its own banking and lending facilities and he asked the customer about his income and his financial obligations.
In fact he had a clear overview of the financial obligations of the customer since this guy was a very good customer.
My cousin saw hat this guy had the habit to order a new car every 2 years and that he was still paying monthly fees (including interest) for THREE previous cars.
He could also see that this guy was spending more than half his income on this and he knew that this guy had kids.
So, in spite of his business interest he asked this guy a serious question: Sir are ou certain that it is a good decision to buy this car?
The customer….go FURIOUS and sarted to scream at my cousin: how dare you to mess with my life.
So my cousin had to apologize (sorry, I will not interfere with you ruining yourself financially) and he had learned the lesson that people sometimes do not want to be protected at all against their own mistakes.
In Iceland, there are two type of Foreign Currency related loans. They are effectively the same thing, but presented differently.
1. ISK loan index linked to FX. So in your contract it says you borrow X amount of ISK, but it is linked to FX.
2. FX loan. In your contract it states very clear you are borrowing X amount of FX.
I understand the court has ruled only the first one illeagle. Now, the question is what they are going to do about the second scenario as they are effectively the same thing.
I personally found the law itself and the ruling unreasonable, and unprofessional. If scenario 2 is legal in Iceland, why shouldnt scenario 1? If FX trading is legal, surely borrowing and repaying in FX is legal, even though your monthly payment is made in ISK, that is then converted into FX, no matter how they present this loan to you.
We can all blame the banks/brokers/leasing companies for the mess we are in when it comes to FX loans. However, when we took out a FX loan, we all knew there were risks related, however most of us failed to estimate how big this risk can be, including myself. I looked back in 10 years, and estimated a 30-40% devaluation in ISK for certain period, however believed in the long run, with the low interest rate, it will still be cheaper than a pure ISK loan, which either bears a very high interest rate or was indexed to CPI. It tured out I was wrong. I have an excuse of not being a native and having not experienced the dramatic fluctuation of a small currency. What excuse do most of other native Icelander have, rather than being naive? As a FX loan “victim” myself, I have complete sympathy for anyone in trouble and I do hope there can be some solutions to ease the pain of the households, BUT we also need to face the consequences of our own mistakes. It´s important we learn from our past, which in turn, hopefully, makes us stronger and wiser; rather than burying our head in the sand and just blaming others.
To Niels:
I completely agree with all yours “rules of thumb” from your father. Anyone that follows them will be much better off in the long term, at least financially.
I unfortunately had to learn most of these, through my own mistakes.
To Easy:
Well in most modern societies, except maybe for cities with good public transport system, a car is now normally considered a necessity. But if you really believe that cars are in fact a luxury, you are of course entitled to your own opinions. Am I then correct to assume you never needed one, correct?
I am not sure though were you got your information that MAJORITY of Icelanders actually bought “luxury cars”. This is just based on what I can typically see when I look outside my window. Do you have any specific data to back up your claim?
>>>>A car IS a luxury. Specially a “luxury car” which the majority of Icelanders bought.
@Bjarni,
Personally I think it is very usefull to follow the following rules of thumb. I learned them from my father and I have always obeyed them, I must say with satisfactory results:
-avoid debts for the purchase of goods which are not necessary (I also count cars amongst this btw- I have relatives who worked as car dealers who told me terrible stories about people endebting themselves terribly just because they wanted to drive a fancy car)
-do not invest in a financial product if you do not fully understand it (I am not ashamed to say that on several occasions I did not understand the financial implications of the cool story that the sales manager of the bank came up with and then I simply declined his offer- if a person is unable to explain the merits of a product to you in simple language it is not worthwhile).
– do not trust people who come to you with a great story about a ‘ wonderful oportunity’ (my father even had the habit to look right into the eyes of people who came up to him with such an offer and from certain subtleties he could deduct that they were insincere).
If the opportunity is so wonderful, then why don’t they invest themselves ?
– do not do something ‘ because other people are doing it as well’ . This is a false reason.
More than 10 years ago, when there was an economic bubble all over western Europe I worked at a bank and had a lot of colleagues who started to invest heavily in the stock exchange which was going up all the time back then.
They believed that this boom was always going to last and just kept buying shares.
I saw people around me who (during office hours) started to scream: We must buy shares of XXXX . This wil be a big hit! And others would immediately buy shares from XXXX, no a few but really for 40.000, 50.000 guilders, even without knowing anything about the comany XXXX.
I did not participate (I must admit that I felt tempted but my father told me not to do it and in stead pointed me to some wise and stable investments) and some colleagues poked fun at me calling me a loser who was missing out on great opportunities.
But then the bubble came to an end and many of these guys suffered losses, not just a little bit but really a lot (one of them lost 700.000 guilders in one day I remember) while I had made a 4 % profit on my investment.
I can tell you that the very same people who had been laughing at me now were very jealous.
By the way, most of the FC indexed loans, were for purchasing or leasing cars, not for “unnecessary luxury goods”.
I read Niels’ “luxury goods” comment as referring to those cars :) .
@Bjarni: A car IS a luxury. Specially a “luxury car” which the majority of Icelanders bought.
@Niels: You said: “The picture of icelandic society which you are painting is that of naive and totally incompetent people.”
Yep!! In fact like 60 Minutes put it, it was literally a bunch of farmers and fishermen with suits, its sad but this is actually true. Just look at what happened, and what is worst, how have we handeled afairs after.
“Were they unable to think independently?” Yep again!!
To Niels:
By the way, most of the FC indexed loans, were for purchasing or leasing cars, not for “unnecessary luxury goods”.
Personally I never liked the idea of FC indexed loans, and strongly recommended against them to anyone that asked. It is just crazy to borrow in different currency than your regular income. But many people chose them, at least partially because they thought “everyone else” was doing it. They are now almost all facing bankruptcy, unless those loans are reset to ISK indexing.
“Will it be possible, for example, for a lender to demand more money from a borrower, that already paid up his loan?
What should be done, in cases where a borrower has already defaulted on a FC loan, and the car has been repossessed and sold? ”
There is a possibility that all loans would be converted to standard ISK loans at the current exchange rate from TODAY’S date or that existing loans would stay as they are and new FC loans banned.
Retrospectively changing the terms of the loans would be a nightmare.
To Niels:
To Niels:
Basically, when you have a complete mess like this, it is important try to figure out exactly WHY it happened, whether you agree with what was done or not.
Personally, I of course do not know exactly “why” no one checked the relevant laws, before issuing loans based on FC, when they clearly the state that FC indexing on ISK loans is illegal.
It is possible the leasing firms were indeed aware of the 38/2001 laws, but did not think they applied to their situation. Possibly they believed the arguments that were used in the district court case (points a) and b) in the earlier comment), which now have been ruled as wrong. This case is not over, and it might very well be that the Supreme Court rules that indeed these loans are legal. Although on the face of it, based on the district court ruling, it is difficult to see how.
But it is also perfectly plausible scenario that (almost) everyone in Iceland were simply not AWARE of these laws, or did not understand them correctly. Normal people in Iceland typically do not read legal documents, and most companies do not have lawyers on hand (until they get into trouble). You can do almost everything in Iceland, including running companies, without ever talking to a lawyer.
That is not an excuse, it is just the way things are over here. It is just a part of living in a small society, where things almost never go wrong. Lawyers and courts play a very minor role here in the daily lives of most people.
If you want to call this naive, you would be partly right. Most people in Iceland are indeed relatively naive, when it comes to financial or legal matters. And I think there is no question anymore, that our government was very incompetent in handling the dangerous financial situation in the run-up and during the crash.
Bjarni, you said:”It is important to remember how small the Icelandic society actually is. These leasing companies are typically not very large, and probably did not have a law department, that would check every thing beforehand. It is therefore quite possible that the early adopters of these FC loans, did not fully check the legality. Then everyone else just followed suit, assuming this was legal. Since no one complained, it probably never came up to the surface, until after the crash.
”
Bjarni I very much respect your postings and I think that you have come up with a lot of good arguments but sorry, this does not make sense.
The picture of icelandic society which you are painting is that of naive and totally incompetent people.
These companies were ‘small’. Is this an excuse for offering such financial products?
(and is ‘being small’ an excuse for the icelandic financial authorities to mess up?)
I think it is not wrong to offer something like this to the consumers, but it is imperative to inform people about the fact that this is a very risky choice.
And also people are obliged to inform themselves about the risk that is involved in making a certain investment decision.
I mean, a lot of icelanders on this site have accused dutch and UK depositors of being ‘stupid’ for putting their savings into Icesave.
How does one then judge the decisions of large amounts of icelanders to take loans in foreign currencies, mostly for making unnecesary purchases of luxury goods?
…But apparently people ‘just followed suit’…
Were they unable to think independently?
I am sorry but this is not an excuse.
To Bromley86:
It is basically going to be a big mess. As you point out, some of the borrowers are going to be better off with the existing FC loans (for example those that paid up before the crash), and some with the recalculation. While recalculating the loans with standard CPI indexing, would not be too hard, there are lot of questions on exactly which FC loans this change should apply to.
Will it be possible, for example, for a lender to demand more money from a borrower, that already paid up his loan?
What should be done, in cases where a borrower has already defaulted on a FC loan, and the car has been repossessed and sold?
There is a good chance, at least some of the car leasing companies will go bankrupt as a result of this.
But all FC loans will clearly have to be recalculated in ISK, if the supreme court agrees with this ruling.
It’s going to be interesting. I suppose the thing to do is for all FC loans to be treated as if they were ISK loans from day one. They then get indexed and have interest added to them. Which is unfair, of course, as it’s quite probable that people would not have taken the loans out in the first place if they knew that they were carrying an effective 15-25% interest rate.
Makes you wonder which route will be better for people. Presumably always the indexed ISK loan for more recent loans (as they’re the ones that would benefit least from the low interest rates and suffer most from the currency devaluation), but loans from 2001 might be better off as FC loans?
The actual ruling by the district court can be found here:
http://www.domstolar.is/domaleit/nanar/?ID=E200907206&Domur=2&type=1&Serial=1&Words
Here it is with Google translate:
http://translate.google.com/translate?js=y&prev=_t&hl=en&ie=UTF-8&layout=1&eotf=1&u=http%3A%2F%2Fwww.domstolar.is%2Fdomaleit%2Fnanar%2F%3FID%3DE200907206%26Domur%3D2%26type%3D1%26Serial%3D1%26Words&sl=is&tl=en
To Peter – London/Krakow:
Borrowers in ISK, have no claim since their loans are still clearly legal. But all FC loans will clearly have to be recalculated in ISK, if the supreme court agrees with this ruling.
Exactly how this could have happened, I am not sure. Before the laws 38/2001 that the court referred to were passed, tying loans to foreign currencies was indeed legal, but one of the purpose of the 2001 laws was to change this.
The leasing company in question, claimed mainly two things in its argument:
a) This was not a loan agreement, but rather a purchase-leasing agreement for a car, which would not be subject to the 38/2001 laws, but this was not accepted by the court.
b) This agreement was a mix of 50% in foreign currency and 50% in Icelandic kronas, and therefore laws 38/2001 would not apply. This was not accepted by the court, as the purchase price for the car was stated in Icelandic kronas in the agreement, and each monthly payment was made in Icelandic kronas.
As for your funny suggestion about the mass delusion, actually if you think about it, it might have some truth in it. Until the crash, the borrowers were quite happy these FC loans, as they meant lower payments. So it is quite possible that there were no legal cases brought forward, to clarify whether these kind of purchase-leasing agreements were actually subject to these laws. Clearly the leasing company did not think so.
It is important to remember how small the Icelandic society actually is. These leasing companies are typically not very large, and probably did not have a law department, that would check every thing beforehand. It is therefore quite possible that the early adopters of these FC loans, did not fully check the legality. Then everyone else just followed suit, assuming this was legal. Since no one complained, it probably never came up to the surface, until after the crash.
Bjarni
“The potential loss to the banks in doing this “conversion” will be huge, but it could be said they were probably were going to loose the money anyway, due to bankruptcies.”
They also will have to compensate those people who aid more to take out a ISK loan rather than gamble on a foreign currency loan. Or are FC loans going to be recalculated to the rate charged on ISK loans and the payments recalculated, together with back interest?
Assuming this was going on in other then a few isolated instances, how is this possible if what you wrote below is accurate ?
Are we to believe that Icelandic lawyers and mortgage bankers are incompetent too ? Or was everyone under some mass delusion and looking the other way while the money was rolling in ?
“In articles 13. and 14. it is clearly specified that the only legal way to index loans, is to tie it to “vísitala neysluverðs” which is basically an Icelandic version of a consumer pricing index (CPI).”
The issue that is here being fought over legally, is whether a loan issued in ICELANDIC kronas, is allowed to be indexed in FOREIGN currency? It remains still perfectly legal to issue loans in foreign currency.
The trouble for the banks, is that these were always loans in Icelandic kronas, and only the indexation was in foreign currency. These loans were quite popular, as they carried lower interest rates than than traditional loans in Iceland that were either fixed rate or indexed to inflation. Plus, during the bubble years the Icelandic krona was rising fast, which further lowered the payments.
Now, after the crash, these loans are causing lot of problems. In many cases they have more than doubled, or even tripled in value, and many of the people with those loans are now facing bankruptcy. You could easily say that this was their own fault, as they should never have taken loans in a different currency than their income. That is just basic common sense.
The banks and the leasing firms (many of these are car loans), bear part of the responsibility here though, as they were pushing these loans very hard. “Do you want your loan in Swiss francs or Japanese yens?” was a typical question.
If you read the current laws 38/2001 on the books regarding interest and indexing, they clearly back the borrowers position.
http://www.althingi.is/lagas/137/2001038.html
In articles 13. and 14. it is clearly specified that the only legal way to index loans, is to tie it to “vísitala neysluverðs” which is basically an Icelandic version of a consumer pricing index (CPI).
Furthermore, in the accompanying law notes (most Icelandic laws contain explanation notes, that explain how to interpret them), it specifically states that these laws beyond any doubt, make it ILLEGAL to index any loans, issued in Icelandic kronas, to foreign currencies.
http://www.althingi.is/altext/126/s/0872.html
So you can see, we are not only fighting with foreign governments. There are lot battles going on internally in Iceland, against the banks, the politicians, and the business elite, most of which never makes the news outside Iceland. :-)
This judgment is of course creating a lot of discussion in Iceland at the moment. There are thousands of loans that are affected by this and the amounts in question are in the billions. The thinking is, that new laws will need to be passed, where it is specified how to handle this situation. Most likely all these loans will have to be recalculated using either the prevailing fixed rates or indexed to inflation as traditional loans.
The potential loss to the banks in doing this “conversion” will be huge, but it could be said they were probably were going to loose the money anyway, due to bankruptcies.
When are Icelanders going to take responcabilety for they’r actions and they’r poor spending habits …This is nuts they think they can chance the whole world to suet them selfs and cover they’r stupit mistakes,
On what planet were these people living. Years ago the Icelandic government borrowed Yen because of its very low interest rate, when it came to maturity they owed twice the amount they’d borrowed due too the massive revaluation of Yen against global currencies. Did these latest borrowers believe that the Kroner would not devalue, or as one suspects the low interest rate was all they saw. Whether or not this product should have been sold to the public is a different matter.
Leave currency trading to the professionals they get paid to get it wrong.
When the court rules out it is illegal, what will it mean to massive people who have foreign currency loan in their hands?
“exchange rate indexation is indeed illegal; but it is not illegal to lend in foreign currencies and then secure repayments in those currencies”
In other words it is ilegal to index forign currency loans to inflation, but its not ilegal to lend and collect in forign currency. The only thing they will do is to change the indexation and put a fix interest, which they will decide.
Isn´t it just the same?? anyways they can say: “I lent you 20,000 Euros for a car, you pay me 20000 euros for the car” still 20,000 was about 2,000,000ISK and today is 3,600,000ISK, so whats the good thing about it?? they are just playing with peoples minds, the only good thing about this is that they can say in the news: “Court rules in favour of Icelandic foreign loan holders” pathetic.
A balancing act between the understandable desire to shaft the (mainly foreign) owners of the banks to protect the entirely Icelandic debtors and not creating another bank crash.
This judgement will surely be overturned in appeal.