Indonesia, Iceland and the IMF

By Dr. Terry Lacey – Jakarta

The collapse of the Icelandic banking system in October 2008 came during the final months of the most unpopular American President in living memory, who presided over a Wall Street crash, leading to a recession.

As the sub prime mortgage crisis grew in the U.S. in 2007, the seeds of the banking crisis were already there in Iceland and Britain. 

In 2007 the Economist ranked the Icelandic krona as the most over valued currency in the world. Icelandic consumer debt exceeded 200% of disposable income. Icelandic debts were too big and the Central Bank too small to function as the lender of last resort.

In the UK a home-grown financial crisis built up based on easy access to housing loans and credit cards, plus emerging weaknesses in banks with too many high risk loans and exposed to toxic U.S. debts. By September 2007 the British Northern Rock bank needed state liquidity support. By February 2008 it was bankrupt and nationalized. Nine months later the British banks crashed.

The view in Asia, the Middle East and Muslim world is that the Wall Street crash reflected systemic weaknesses in U.S.-led capitalism, shared by Western countries like the UK and Iceland. 

These weaknesses included the outstripping of regulatory frameworks by the speed of financial and banking developments, so that regulators and political leaders were unable to keep up with the complexity of instruments and the volume and nature of risks. 
It was the Prime Minister of Iceland Geir Haarde who pointed out that bankers had been making hay while the sun shone but had not put enough aside for a rainy day.

In one year the Gross Domestic Product (GDP) fell 65% in euro and 15% in krona.  

The krona nose-dived from 83 to the euro one year ago to 286 by this December. Many Icelandic companies face bankruptcy or may move abroad. Icelanders have lost savings, jobs, or both. One third of the population of 320,000 is considering emigration.

The Icelandic GDP in 2007 was 1,293 billion krona or 8.5 billion euros. The assets of the three banks taken under the Icelandic Financial Supervisory Authority (FME) were 14,437 billion krona (€94 billion euro). Foreign debts were over €50 billion, at least €160,000 per Icelandic resident.

Three main banks collapsed – Landsbanki, Glitnir and finally Kaupthing and were effectively nationalized in October 2008.  Landsbanki´s Icesave subsidiary had about £4.0 billion sterling deposits in the UK and over €1.6 billion euros in the Netherlands. The crash also affected Austria, France, Germany, Ireland and Luxembourg.

EU countries led by the UK and the Netherlands then delayed the Iceland-IMF deal to force Iceland to agree to extend its bank guarantees to the first €20,887 euros of any default on 300,000 Icesave UK deposits and 120,000 Netherlands Landsbanki accounts. 
The Iceland-IMF negotiations therefore involved conditions imposed by third parties who were powerful within the IMF, as well as IMF conditionality. In the 1997-8 Asian banking crisis, Indonesia did not have to deal with liabilities to third parties.

Many economists are critical of the IMF rescue packages to the UK (1976), Indonesia (1998) and Iceland (2008). The IMF recipe of austerity, high interest rates and lower government spending seems almost the reverse of what is needed to prevent a recession, or get out of one. Iceland now has high interest rates (about 18%) reflecting IMF policies.

By contrast UK Prime Minister Gordon Brown argued since the 2008 Wall Street crash that Keynsian economic stimulus works better than tightening your belt when you are already down. The British Central bank interest rate is now 2% and could fall to 0%.

On October 7th the UK used banking laws to transfer the Landsbanki subsidiary Heritable retail deposits to the Treasury and sold them to the Netherlands ING bank.  On October 8th the UK used its anti-terrorism laws to freeze a reported £4 billion sterling of Landsbanki and Icelandic assets and took over 300,000 bank accounts.

The British Financial Services Authority (FSA) then declared Kaupthing Singer and Friedlander (KSF), the UK subsidiary Kaupthing, to be in default, although the Icelandic case is that Kaupthing was at that stage “battered but still solvent”.

The British FSA then seized KSF and closed it, and sold its online bank Kaupthing Edge to the Netherlands banking group ING, passing over 160,000 accounts worth £2.5 billion sterling (about €4 billion euro).

The final total bailout package related to the Icelandic banking collapse comes to about US$6 billion, with $2.1 billion from the IMF, not counting liquidity support and guarantees to depositors in EU countries. The deal agreed by Iceland was backed by the IMF, Norway, Sweden, Denmark, Poland and Russia.

When the Icelandic bank crash hit British politics along with the British banking crisis, in October 2008, then UK Prime Minister Gordon Brown and Chancellor of the Exchequer Alistair Darling fought to defend their political backyard. Local authority employees, fire brigades, police authorities, London transport services, all depended on Icelandic banks. These were politically sensitive bank clients in the heartlands of Labour support.

The British-Icelandic ´banking war`, was fought over total assets worth perhaps  £8  billion sterling of UK depositors money in Icelandic banks, mostly involving Landsbanki, Kaupthing and their UK branches and subsidiaries Icesave and Heritable.

By comparison losses in value in the UK bank crash were more than £92 billion sterling (about €140 billion euros). The assets of HBOS (“Halifax – Bank of Scotland”) fell from sterling  £25.5 billion to  £6.7; of Lloyds TSB from  £30.9 billion to  £11.3 ; of the Royal Bank of Scotland  from  £41.7 billion to  £11.9 and of Barclays from  £41 billion to  £17.4.

The British Government injected £11.5 billion into HBOS, £5.5 into Lloyds (which also acquired HBOS) and £20 billion into RBS. The result is that the state nationalized, with an injection of £37 billion, 60% of the RBS and over 40% of Lloyds-TSB-HBOS.

The nub of the Icelandic case is that increased political popularity for the British Labour Government accrued from strong-arm tactics during the British-Icelandic ´banking war`, should not have included using anti-terrorist legislation against an ally.

The UK then used seized funds, sophisticated EU financial engineering and superior bargaining power to reduce UK liabilities and ensure the Icelandic taxpayer would pick up as much of the tab as possible.

In the Indonesian case the 1998 crash was preceded by a decade of rapid expansion of the banking system, from 119 banks in 1991 to 238 by 1997. The root causes of the Indonesian crash were over-expansion, rapid liberalization alongside poor regulation and a rapid increase in non performing loans due to corruption and crony capitalism.  

Standard & Poor estimated the total fiscal cost of the Indonesian bank bailout was $87 billion, when the GDP was $107 billion. The IMF bailout package was for $10 billion.

Meanwhile over 460 small Peoples Banks, 5000 local BKD microfinance credit outlets and 1600 LDK microfinance outlets owned by local government survived profitably.

The network of over 460 small secondary Peoples Banks lending microfinance also survived the crash, without any dollar economy links.

Similarly SME portfolios in conventional banks remained largely intact.

The poor kept the economy going while the rich floundered. As in the Western recession now, poorer workers and taxpayers were required to bail out the rich. 

In the 2008 crisis Indonesia has a fundamentally strong banking system. The country has access to a $6 billion standby loan from the World Bank, Japan, ADB and Australia to help bolster the economy in case its 2009 economic growth should fall below 5.8%.

Perhaps Indonesia and Iceland could now help each other. Indonesia has a total geothermal energy potential of 27,000 MW but is committed to develop 9,500 MW of geothermal energy by 2025, with only less than 1,000 MW developed so far.

Icelandic know-how could help develop Indonesian geothermal energy, providing revenue to Iceland and electric power to Indonesia.

So maybe every cloud has a silver lining. In this case a steamy cloud smelling of eggs could be a goose that lays golden eggs for both countries, perhaps with help from Islamic finance.

Islamic finance has nothing to do with Ali Baba and a magic carpet and everything to do with a modern adaptation of shariah law to supply up-to-date financial products comparable to those offered by modern conventional banking but applying bank charges rather than interest and not based on Western concepts of debt.

However there is no magic carpet to fly Iceland into the Eurozone without joining the European Union.

Iceland needs to join the EU, the UK needs to join the Eurozone and the EU needs to modernize itself and help build a more equitable new international economic order.

Time for Iceland to join the EU and come in out of the cold.

Time for the EU, especially the British, to make up for their rather heavy-handed management of the Icelandic banking crisis,  to actively support Iceland´s entry into the EU, and help tidy up remaining wreckage and casualties on the banking battlefield.

– Dr. Terry Lacey is a development economist who writes from Jakarta, Indonesia, on modernization in the Muslim world, investment and trade relations with the EU and Islamic banking. He contributed this article to Palestine Contact him at:

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