The Financial Supervisory Authority and the Central Bank of Iceland have decided to issue guidelines to financial institutions due to non-binding clauses linking loans to the exchange rate. They will then present these guidelines at a joint press conference. The guidelines are as follows:
(Central Bank of Iceland press release)
Guidelines issued by the Financial Supervisory Authority and the Central Bank of Iceland to financial undertakings due to non-binding clauses linking loans to the exchange rate
On 16 June 2010, the Supreme Court of Iceland handed down two decisions pertaining to the legality of linking loan obligations in Icelandic krónur to the exchange rate of foreign currencies; cf. Cases no. 92/2010 and 153/2010 begin_of_the_skype_highlighting 153/2010 end_of_the_skype_highlighting. The Court concluded that such exchange rate linking was non-binding.
Until a final conclusion has been reached concerning the scope and terms of the loan agreements affected by these Supreme Court judgments, it is especially important to gather reliable information, create stability in financial market transactions, and promote a secure and effective financial system.
The Financial Supervisory Authority and the Central Bank of Iceland therefore direct the following guidelines to financial undertakings:
1. Loan agreements that, in the opinion of the financial institution concerned, contain non-binding exchange rate linkage clauses (cf. the above-cited Supreme Court judgments) shall be recalculated. Instead of linking the loan agreements to foreign exchange rates and interest rates, the institutions shall calculate the loans based on interest rates determined by the Central Bank of Iceland, with reference to the lowest interest rate on new, general, non-indexed or indexed loans from credit institutions, which rates shall be used in cases of uncertainty about loan terms – cf. Articles 4 and 18 of the Act on Interest and Price Indexation, no. 38/2001 – unless the parties agree otherwise.
2. Loans shall be treated based on the aforementioned premises as soon as is practicable. If, for technical reasons, a financial institution cannot comply with these guidelines immediately, it shall ensure that payment amounts are aligned with the above guidelines as closely as possible, and that they are fully in compliance with the guidelines no later than 1 September 2010.
3. Financial institutions shall re-assess their economic capital in view of these conditions and shall ensure that it is sufficient to cover potential asset erosion over and above that which derives from Item 1 above.
4. Reporting to the Financial Supervisory Authority and the Central Bank of Iceland on foreign exchange balance, liquidity, and capital adequacy shall be based on the above-specified premises.
There is a lot of pent-up anger going on behind this story that is probably not getting much exposure outside Iceland. Just like the “pots-and-pans” revolution, and the fight against the Icesave agreements, this is driven by ordinary people writing blogs. And, as usual the government is caught with its pants down, and doesn’t even know how to react.
First few points, that I think will explain the main issues involved:
1. At the time when these loans were issued, they were considered perfectly “normal” by most people, even though everyone with basic understanding of finance should have realized that taking consumer loans in different currency than your salary, is actually very dangerous.
2. Consumers in Iceland have over the years been offered 3 basic types of loans:
a) unindexed (at very high +20% rates)
b) ISK-indexed (typically at 5-10% over the official CPI).
c) FC-indexed (low 3-5% rates in various mix of currencies)
Its not difficult to see why many “normal” people would decide to go for option c), however stupid that may have been risk-wise.
3. The parliament in Iceland passed laws 2001/38 which removed the permission to issue FC-indexed loans, if the loan itself was paid in Icelandic kronas (FC loans were still allowed):
http://www.althingi.is/lagas/137/2001038.html
The relevant articles regarding indexing are 13. and 14. In the explanations for the bill there is the following sentence:
http://www.althingi.is/altext/126/s/0872.html
“Samkvæmt 13. gr. og 1. mgr. 14. gr. frumvarpsins verður ekki heimilt að binda skuldbindingar í íslenskum krónum við dagsgengi erlendra gjaldmiðla. Er talið rétt að taka af allan vafa þar að lútandi.”
Basically it says: “…it is not allowed anymore to index ISK loans to foreign currencies. It is correct to remove all doubt about this.”
Considering how blunt this statement is, for some reason this law was completely IGNORED by the banks and the car-finance firms, which in and by itself is amazing.
Furthermore, this new law was never enforced by the authorities or the regulators. It is interesting to note though, that the Icelandic Central Bank apparently stopped later publishing penalty rates for foreign currencies, as it “assumed” no such loans would be collected anymore.
4. About 40-50 thousand people took these FC-indexed loans, and paid a very high price when the ISK crashed in 2008. In many cases these loans have doubled, even tripled their balance, causing large number of bankruptcies and extreme hardships for many people.
5. The car-finance companies (most FC-indexed loans were for cars), have been extremely harsh in dealing with consumers that got into trouble with their payments. There have been lot of stories, about how they have repossessed the car, computed all kinds of “phony” charges to lower the recovery value of the car down to a fraction of the actual value, and are still going after the consumer for the bulk of the original loan (which is still worth 2-3 times the car). Nobody will cry over the car-finance companies going bankrupt.
6. The real trouble for the government is that the banks were also issuing large number of FC-indexed loans, and also lending money to the car finance companies. This is what they are so worried about, that it will not be only the car-finance companies that go under, but perhaps the whole banking system again. (Note that they cannot say this publicly, as in and by itself that would likely cause a crash). The potential losses for the banking system by this ruling have been estimated to be about 100B ISK (about 640M EUR).
7. The Supreme court in its judgement determined three things: a) the agreements in question were indeed loans (in order for laws 38/2001 to apply), b) the loans were issued in ISK (in some cases the loans agreements specify FC, even though the purchase, and all payments are in ISK), c) Loans based on FC-indexing are illegal according to laws 38/2001. Unlike many others involved, the courts have actually handled this reasonably well, but they of course do not have to pay for any of this.
8. The legal situation is actually pretty straightforward. The loan agreements themselves have NOT been ruled illegal, just the FC-INDEXING of those loans. The Supreme Court judgment says nothing about applying any other interest or indexing instead. It is the opinion of the people fighting against the finance companies, that no other indexing can legally be forced on these consumers, so they are required only to pay the low 3-5% interest rate (which is a gift considering the high inflation in Iceland).
9. The government, which was caught completely unprepared (unfortunately as usual), basically left it to ICB and FME to come up with a “political” solution, which are these guidelines described in the article above (everyone pay the Central Bank Rate, until things are clarified further by the courts).
10. So far the response to these guidelines has been welcomed by the finance firms, but at the same time they are vehemently opposed by the consumer advocates and the bloggers. For some examples of what they are saying, here are some of the most prolific (unfortunately all in Icelandic – please use Google translate):
http://marinogn.blog.is/blog/marinogn/
http://blog.eyjan.is/larahanna/
http://rlingr.blog.is/blog/rlingr/ (extremely detailed analysis of typically loan agreement by SP-Fjármögnun, one of the car finance companies involved)
http://www.heimilin.is/varnarthing/
http://gandri.com/
This is basically a BIG mess, with no easy solution. And the stakes are high, as bad outcome could possibly cause the banking system in Iceland to crash again. Any solution has to work BOTH legally and politically.
Legally, the issue is relatively straightforward, the loan agreements stay as they are written, just without the FC-indexing (the illegal part).
Politically the situation is more or less impossible. Either, the government let the agreements stay unchanged, with massive losses to the banks and possible crash, which would have to be covered again by the tax-payers (which are still very angry over the last crash). Or, the government can try to get a ruling from the courts or pass new laws, that somehow force the consumers to pay additional interest on top or be indexed to CPI. There is a big question however, whether such laws would actually be even legal according to the constitution and/or the EC regulations protecting consumers.
I haven’t seen people this worked up and angry in Iceland for quite a while, well at least not since the Icesave agreements. There was some news yesterday that the discussions with UK/NL were starting again, and nobody in Iceland seemed to even notice. :-)
If the bankers who own the car finance companies are going to ignore the Supreme court desicion after braking the law, then they should not expect to see anyone to pay a red cent,
what this guy who towed the Lysing “owned” car did was just a foretaste of what can be expected, he intends to keep the car until they pay him what they owe,
an eye for an eye and a tooth for a tooth, makes perfect sense to me.
This is only a temporary solution, does not change anything,
the interest rate argument is not the only ploblem for the finance companys, they are going to be swamped in laws suits, all kinds of stuff no one could ever explain or make excuses for.
One example, SP fjarmognun car loan,
A woman took a foreign currency loan to buy a car, in the beginning of 2008 the loan was 5,4 million ISK, the woman stopped being able to keep up with payments in the fall of 2008 when the loan had gone up to 10 million, the car was reposessed and SP makes a estimate of value, according to the contract SP should have used the BGS car price calucaltor (BGS is a independent organisation in the car industry), 5 months after reposession a similar car costs 8 million, the car dealer Askja estimated the trade in price 5,5 and sale price 7, according to SP the estimate they used came from 2 car dealers, one estimate was for 5,5 and the other 4,5, SP decided to estimate the car for 4,2 and then lovered that estimate by 20% without any explanation, then they lowered that amount by another 15% because of a clause in the contract allowing that because of cost until SP would sell the car,
then the car was down to 2,9 million, then the condition of the car was estimated, shock absorbers, tires, paint on hood, new rust coat and more plus 250k kr unexplained fee added up to 840k,
in the end the 2 year old car was taken for 2 mil and the 10 mil debt lowered to 8 mil, the woman was sued for the 8 mil, soon after this SP sells the car for 5 mil but still demands the 8 million.
http://www.ruv.is/frett/sp-brytur-eigin-skilmala
There is a large number of similar cases, some far worse than this,
there seem to be some issues with accounting and tax payments aswell.
One guy who is saying he went into a storage area belonging to a car loan company called Lysing and towed one car away, he says he didnt steal the car from Lysing anymore than they stole a car from him.
http://eyjan.is/2010/07/01/reidin-magnast-segir-lysingu-skulda-ser-og-stal-thvi-bil-sem-tryggingu/
I would not be surprised if a lot of people involved in this ended up behind bars.
“Now I’m confused. Would anybody like to explain what this means in practice?”
To relieve the Icelanders of poverty; so, perhaps, they would get well sooner!
Really it is a trick but …
Now I’m confused.
Would anybody like to explain what this means in practice?