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Governance, Iceland, and the IMF

The Icelandic collapse revealed shortcomings in the international community’s ability to respond to such an event. This column examines the IMF’s central role and recommends that it formulate rules to address potential conflicts between its own lending and external bilateral creditors. It should also establish a mechanism for international investigation when a country’s banks impose severe financial losses on their foreign creditors.

Throughout its 65-year history, the IMF has sounded two leitmotifs in its balance-of-payments assistance to member countries.

  • First, assistance beyond a certain predetermined threshold needs to be accompanied by improved policies to help put the borrowing country back on track and fortify its ability to pay back.

Fund conditionality aims in most cases at fiscal and monetary restraint where appropriate and avoiding debilitating currency overvaluation and exchange and trade restrictions.

  • Second, all members need to be treated equally in terms of their access to IMF resources and the strings attached, while at the same time due attention needs to be paid to local circumstances.

One size does not fit all Fund-supported programs. Following a few years of relatively modest lending activity after the Asian crisis of the late 1990s and the Argentine debacle of the early 2000s, the IMF is now back in business, having recently been called upon to assist a number of countries with stand-by arrangements, including Hungary, Iceland, Latvia, Pakistan, and Ukraine in 2008 and Mongolia, Romania, and Sri Lanka in 2009 in addition to other program lending around the world. To meet this surge in demand for its services, the Fund has doubled its financial resources.

Shared conditionality?

The Icelandic case (Danielsson and Zoega, 2009) raises a couple of questions that may have implications beyond Iceland’s shores. First, Iceland’s financing gap of about $5 billion during 2008-10 significantly exceeds the IMF’s capacity to bridge the gap, given Iceland’s small quota in the Fund that reflects Iceland’s small size (GDP $11 billion, pop. 320,000). This is why the Fund must limit its contribution to the loan package to about $2 billion, which amounts to nearly 1,200% of Iceland’s quota. This amount is equivalent to about $6,500 per person in Iceland, compared to $1,600 per person in Hungary and $600 in Latvia.

Iceland needed more money than this to build up enough foreign exchange reserves to insure that the government can honour its overseas obligations and keep the Icelandic króna above sea level when the temporary capital controls imposed under the program are relaxed. The rest of the money had to be raised elsewhere. The Nordic countries – Denmark, Finland, Norway, and Sweden – offered another $2 billion. The rest was raised from the Faroe Islands, Poland, and Russia.

When lenders disagree

Understandably, external contributors to an IMF-supported program may, for similar reasons as the Fund itself, wish to insist on assurances as to improved policies or performance in other respects to rebuild vanished confidence. It is not obvious, though, that the external partners’ ideas as to what constitutes the most appropriate assurances fully coincide with those of the Fund.

It has been known for some time that the Nordic countries would like the Icelandic government to settle its dispute over the compensation of British and Dutch depositors in the IceSave internet accounts of Landsbanki, one of Iceland’s three failed banks. It only recently came to light, however, that without such a settlement the Nordic countries are not prepared to go ahead with their support for the Iceland program. This was not made clear when the Icelandic authorities’ Letter of Intent was published in November 2008, stating inter alia (clause 9):

“Under its deposit insurance system Iceland is committed to recognise the obligations to all insured depositors. We do so under the understanding that prefinancing for these claims is available by respective foreign governments and that we as well as these governments are committed to discussions within the coming days with a view to reaching agreement on the precise terms for this prefinancing.”

Without Nordic support, the program would have to rely on more radical adjustment to make up for reduced financing.

The Icelandic government subsequently signed agreements with the British and Dutch governments to the effect that Iceland would repay Britain and the Netherlands about half of the sum that they had taken upon themselves to pay out to compensate in full the IceSave depositors in the two countries, even though the IceSave accounts were operated by branches rather than subsidiaries of Landsbanki and, therefore, by law, were subject to Icelandic rather than British and Dutch deposit insurance and supervision. The amount paid out by the British and the Dutch was roughly equivalent to Iceland’s GDP in 2009. Iceland was asked, and agreed, to pay half of that amount back to Britain and the Netherlands at 5.5% interest over a period of seven years, 2017-24. The Icelandic Parliament then appended unilateral reservations to the deals in an attempt to limit Iceland’s commitment to pay should economic recovery from the crisis fail to proceed as envisaged, thereby dimming the prospects of Iceland’s ability to honour its obligations in accordance with the agreements. The British and Dutch governments seem reluctant to accept these reservations.

The IMF’s role: Helping crisis-stricken nations, not third-party claimants

The fact that the IMF’s conditionality framework does not explicitly allow for conditions laid down by bilateral creditors such as the Nordic countries in this case undermines the transparency that the Fund aims at in its dealings with member countries. As a matter of record, Britain’s Prime Minister, Mr Gordon Brown, told the British Parliament that he discussed his government’s dispute with Iceland over the IceSave accounts with the management of the IMF. The IMF may need to adopt explicit in-house rules for how to deal with the conditions that external bilateral creditors and possibly others may wish to impose on Fund members seeking assistance. The people have a right to know who asks for what. If they know, they will be more likely to realise the logic behind the Fund-supported program. The IMF’s role is to help its members, not third parties. If conditionality is, in fact, shared among the IMF and bilateral creditors, the rules of engagement need to be clear.

International commission of inquiry

Ever since the Icelandic banks collapsed in October 2008 (Buiter and Sibert, 2008), there have been vocal demands in Iceland for an international commission of inquiry into what went wrong. It is a serious matter for any country to see its recently privatised banks default on foreign loans equivalent to perhaps three, four, or five times GDP, especially when criminal misconduct is suspected by the Financial Supervisory Authority and the general public alike.

The demands for a foreign inquiry echo concerns that, before the onset of the crisis, the tight embrace between the political class, the banks, and the business community would jeopardise the credibility of any investigation offered by the government in the eyes of a large segment of the population. To illustrate the point, the Icelandic Chamber of Commerce paid Professor Fredrick Mishkin of Columbia University $135,000, as reported by the Wall Street Journal, for co-authoring a 2006 report dismissing warnings of pending financial instability in Iceland. Iceland’s Minister of Foreign Affairs, Mr Geir Haarde, who was Prime Minster when the banks collapsed in 2008, shared the podium with Professor Mishkin in New York on 3 May 2006 when the latter presented the report that bears his name. This event was part of a road show in which a revolving cast of Icelandic business leaders, bankers, and politicians tried to calm foreign creditors and investors. The show went on until briefly before the collapse.

In a closely interwoven community with weak checks and balances and a weak culture of accountability, there is a need for impartial outsiders – respected former public officials and academics, for example – to tell the people what went wrong and to produce a correct, or at least believable, record of recent history. Domestic investigators may have stood too close to the events leading to the collapse, especially in a country where the political class has moulded the judicial branch of government in its own image.

The Icelandic government has aroused distrust by its firm opposition to an international inquiry. This is where the IMF might enter the picture. If a country’s banks impose severe financial losses on their foreign creditors, it is natural for the local population as well as the international community to insist on a proper accounting for how this happened. This can be done either by setting up a new international office to organise such inquiries or, more simply, by vesting the task in an existing institution such as the IMF under a new set of rules intended to secure the independence and impartiality of the investigating body. In the case of Iceland, this would have meant that the IMF would have had an explicit authority to suggest, and perhaps even insist on, the setup of an international inquiry into the bank collapse in connection with, or as part of, the Fund-supported program. Such an arrangement could make a Fund-supported program look more attractive to a people facing a choice between a program plus an impartial international inquiry and no program plus a suspect domestic investigation or none. However, if countries in need of assistance from the IMF feared that they might have to accept an international inquiry, they might delay seeking assistance. The net effect of those two forces on the demand for access to Fund resources seems ambiguous.

Credible crash analysis

The National Transport Safety Board investigates every civil-aviation crash in the US. In Europe, national Civil Aviation Accidents Commissions perform this vital role. Their principal concern is public safety. In this regard, there is a case for viewing finance the same way as civil aviation. This is why, when things go wrong, there needs to be a trustworthy mechanism in place to secure full disclosure. If national governments hesitate, perhaps because they may have something to hide, the international community needs to consider mutually acceptable ways to fill the gap.


Buiter, Willem and Anne Sibert (2008), “The collapse of Iceland’s banks: the predictable end of a non-viable business model”, VoxEU.org, 30 October.

Danielsson, Jon and Gylfi Zoega (2009), “Entranced by banking”, VoxEU.org, 9 February.

Wall Street Journal (2007), “The past (lucrative) life of Fed’s Mishkin”, Real Time Economics, 1 August.

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