By Nikoletta Kleftouri

n 2008, Iceland experienced one of the worst financial crises in history, which involved the collapse of all three of its major commercial banks. 

The causes of this collapse were numerous and complex, and included the banks’ difficulty in refinancing their short-term debt and a run on their deposits (a bank run is a situation in which a large number of bank depositors withdraw their deposits simultaneously due to concerns about the bank’s solvency). The Icelandic banks had sought capital to a great extent abroad, first in the European debt securities market and later in the American debt securities market. The global reduction in liquidity in financial markets that began in 2007 soon blocked this access, and ultimately led to the collapse of the banking sector.

The assets of those banking entities were equal to more than 9 times the Icelandic GDP, meaning that they were controlling amounts of money far greater than the country’s own wealth and there was no pos­sibility for the Icelandic government and central bank to step in and provide financial assistance or rescue (‘bail out’) those entities.  Separately, the Depositors’ and Investors’ Guarantee Fund, a fund which is designed to protect eligible depositors up to a certain limit (20,887 EUR at the time), had very scarce resources in comparison with the bank deposits it was meant to protect.

The Icelandic banking system had become ‘too big to control’ and most importantly ‘too big to save’.

As a result, in the autumn of 2008, the three largest commercial banks, ‘Glitnir’, ‘Landsbanki’, and ‘Kaupþing Bank’, were resolved (i.e. they were split into ‘old’ and ‘new’ banks by the authorities).  The banks’ domestic assets and liabilities (including deposits) were placed into the ‘new’ banks and received full protection. Foreign assets and liabilities (including foreign deposits) were mainly placed in the old ‘banks’, and subjected to winding-up procedures. These procedures could not ensure that losses are not imposed on creditors, including depositors, as their aim is the eventual closure of operations.

Iceland also imposed strict controls on capital movements, inward as well as outward, which were originally envisaged to be in effect for 2-3 years. Instead they have lasted almost seven years and it was in June 2015 that the government announced a strategy to gradually lift them.

Four years after the Icelandic crisis, in 2012, history repeated itself and we saw another example of a banking system that was both ‘too big to control’ and ‘too big to save’ comparing to the size of the country’s economy: the Cypriot banking crisis. Among the factors that contributed to that crisis were: banks’ exposure to overleveraged local property companies, the Greek government’s debt crisis, banks’ risky expansion strategies, and the reluctance of the government to restructure the troubled Cypriot financial sector.

In March 2013, the country agreed with international lenders to resolve its two largest banks, Cyprus Popular Bank (also known as ‘Laiki Bank’) and the Bank of Cyprus. Laiki Bank’s business was partially transferred (e.g. good assets, covered deposits, and the entire amount of deposits belonging to financial institutions, the Cypriot government and other public entities) to the Bank of Cyprus, with the exception of those subsidiaries and branches that were not located in Cyprus (e.g. Greek branches of Laiki Bank and Bank of Cyprus were sold to Piraeus Bank). Uncovered deposits (i.e. deposits that exceeded the amount of 100,000 EUR) were not protected and transferred to a ‘bad’ bank which would be liquidated over time. In the case of the Bank of Cyprus, the bail-in resolution tool was applied, meaning that losses were absorbed by the bank’s shareholders and unsecured creditors, including uncovered depositors, through the conversion of existing shares and debt to new shares.

Cyprus was the first rescue by international lenders with a condition to impose losses on bank depositors, a measure considered inconceivable until then. The rescue agreement was followed by a closure of the entire banking sector for nearly two weeks with the imposition of capital controls with a view to preventing a bank run. Just as Iceland, Cyprus expected to institute capital controls for a short period of time, only to unwind them this year.

And as history continues to repeat itself, Greece imposed capital controls in late June 2015, in an attempt to prevent a bank run and the collapse of its banking sector. The causes of the Greek financial crisis are numerous yet different to some extent from those of the aforementioned cases; they relate, among other things, to the unsustainable debt that the government has been borrowing, the five years of unsuccessful efforts to stem the burgeoning crisis and the design of the Eurozone. The consequences are nevertheless the same: the Greek banks are currently in need of a substantial restructuring and the question of how their depositors would be treated is still unsettled.

The country’s banking system was once ‘too interconnected to fail’ but this is, arguably, no longer the case as Europe has put up safeguards to limit financial contagion and keep the problems from spreading to other countries. Iceland’s and Cyprus’ recoveries have been just as impressive as their crises; it remains to be seen whether history will repeat itself in this respect for Greece as well.