Iceland should stand up to shameful bullying

John Kay is one of Britain’s leading economists. His interests focus on the relationships between economics and business. His career has spanned academic work and think tanks, business schools, company directorships, consultancies and investment companies. For more details of John’s biography, see the About section.

24 February 2010, Financial Time

The assertion that depositors in Kaupthing and Landsbanki have a claim on ordinary people who were too prudent to put money there, or did not have any money to deposit in the first place, has little justice or legal basis.


When Scotland’s two largest banks were rescued in 2008, their combined gross liabilities totalled more than half a million pounds for each man, woman and child in the country. Most Scots do not have half a million pounds; indeed, many Scots will not earn half a million pounds in their entire working lives. But this does not matter, since the sum is irrelevant. The liabilities of the Scottish banks are plainly not liabilities of the Scottish population, either legally or morally. This would not change one bit if Scotland had an independent government. These points are so obvious that they should hardly need to be made.

That brings us to the referendum planned in Iceland for March 6. The Icelandic situation is a bit more complicated, but the essentials remain the same. The European Union requires that member states allow each other’s banks to seek deposits throughout the Union (and Iceland) under a passport scheme. If the bank operates a branch in another country, the home country is responsible for supervision; if the bank fails, depositors are entitled to compensation in the home country. If the bank operates a subsidiary in another country, that subsidiary will be supervised there and depositors must look to their own country’s deposit protection scheme.

One of the two large Icelandic banks – Kaupthing – operated in the UK through a subsidiary, and the other – Landsbanki – operated through a branch. Supervision was lamentable in both cases. Well before the collapse of Lehman, both institutions were obviously close to the rocks, if not heading directly towards them. Encountering difficulty raising wholesale finance on competitive terms, Kaupthing and Landsbanki sought to raise retail deposits aggressively in the UK.

When these Icelandic banks failed, depositors were entitled to look to the relevant deposit protection scheme for compensation, as EU rules require. These rules forgot, however, to require that these deposit protection schemes had the resources to pay such compensation. Iceland’s scheme had negligible reserves and operated in a bust financial system. In 2008-09, Britain’s Financial Services Compensation Scheme paid out £19.9bn ($30.8bn) and imposed levies of £170m.

Both the Icelandic and British schemes therefore turned to the only possible source: their own taxpayers. The Icelandic government does not have the £3.5bn needed to cover its shortfall. The British government does not have the £20bn needed to cover its own shortfall either. But Britain has 56m people, Iceland 320,000. In the British case, but not the Icelandic, the difference could be hidden within the overall totals of public borrowing.

The assertion that depositors in Kaupthing and Landsbanki have a claim on ordinary people who were too prudent to put money there, or did not have any money to deposit in the first place, has little justice or legal basis. The public might more reasonably be asked to rally round if Britain and the EU acknowledged their own responsibility for past failures or had serious plans to prevent a recurrence.

The passport scheme failed at its first significant test: it is intolerable that weak banks should offer greedy depositors above-market rates backed by government guarantees. Processes for the resolution of failed financial institutions proved inadequate. The only satisfactory means of dealing with these problems requires that banks match their deposits with safe assets ring-fenced within the jurisdiction in which the deposits are collected. The proposition that better regulation in all 27 member states will in future prevent cross-border failures of retail banks is risible.

Our rationale for bullying the people of Iceland is the rationale of all bullies: we are doing it because we can. Or because we thought we could. Now Iceland again has the upper hand. If the vote on March 6 goes ahead the public will be given its first opportunity to reject the claim that it must take financial responsibility for the failures of banks and bankers. That will be a game-changing event, which is why Britain and Holland are negotiating. We should be ashamed of ourselves.

Tags: Fallacies, Finance, Governance, iceland, Regulation