Please paraphrase and summarize about (600 words ) Iceland Reform Iceland is a s
ID: 390487 • Letter: P
Question
Please paraphrase and summarize about (600 words )
Iceland Reform
Iceland is a small country with its own currency and a large, internationally exposed financial industry. Although greater supervision may have lessened the severity of the collapse, its economic model, which was dependent on an oversized financial sector, was inherently flawed. Iceland has made strong attempts to correct the errors in its regulatory system, which will restrict future banks from growing to such unsustainable levels. However, legal reform alone may not be enough to prevent another crisis. The supervisory system, in particular the FME, failed to exercise power over the banks even when it had the legal capacity. A corresponding change in the society’s views on regulation and supervision is needed to supplement the current financial reform. The severe consequences of the financial crisis, including a deep recession, restrictions on currency exchange, loss of real wealth, and a damaged international reputation that change to the Icelandic people. The ideology of a loosely regulated free market, which allowed a banking system to expand dangerously while a weak supervisory framework lost control over the banks, has been called into question. Prime Minister Johanna Sigurdardottir expressed this ideologic shift during the release of the SIC report in April 2010. Mistakes were certainly made. The private banks failed, the supervisory system failed, the politics failed, the administration failed, the media failed, and the ideology of an unregulated free market utterly failed. This has called for a fundamental review of many elements of our society. (Prime Minister’s Office)
The regulatory system was unsuccessful because it lacked the knowledge as well as the will to enforce existing regulations. The supervisory institutions, the banks, Parliament, and the Icelandic people all failed to push for stronger regulatory enforcement until the banks reached a point of no return. Although the crisis severely harmed Iceland, it instilled a healthy sense of distrust that is at the core of financial supervision. The government and the public must demand tighter regulation over the banks, not allowing them to expand in an unrestrained manner because of apparent short-term economic benefits. The foundation of this legal reform is now in place. What remains to be seen is if Iceland keeps financial regulation a priority, maintaining and updating the legislation as financial markets and instruments evolve.
There have been several steps taken by the Icelandic government to make far-reaching systemic reforms, prompted by the conclusions of the two major investigative reports.
Kaarlo Jännäri’s report largely pointed to the deficiencies in the legal framework. His suggested changes included decreasing the number of ministries, merging the CBI and FME,granting more discretionary powers to the FME, creating a national credit registry, applying stricter rules on large exposures and lending to the banks’ own large shareholders, conducting more on-site inspections to verify offsite supervision, and improving the deposit guarantee system. (Central Bank of Iceland, Vol.
5, p. 12) The SIC report had similar conclusions, arguing that the failure was largely due to reckless bank actions that were unobstructed by legislation. However, the report did identify three former ministers, three former CBI governors, and the director of the FME as having shown negligence in their duties. More importantly, the report pointed to the dangerous tendency of supervisory institutions to interpret regulatory options narrowly, thereby allowing banks to bypass regulation with ease. The Commission criticized the regulatory agencies for not making more efforts to investigate the underlying risk of the banking system and for failing to have a governmental contingency plan in place during the collapse. These findings have prompted many of the reforms, discussed in this article, which are currently under way in Iceland.
Act on Financial Undertakings
In response to the Jännäri report, the Ministry of Economic Affairs was established as the administrator responsible for both the FME and CBI, intended to enhance macroprudential supervision. Macroprudential supervision, as the CBI explained in the foreword to the 2010 Stability Report, is a concept promoting the use of “prudential tools to reduce risk in the financial system as a whole rather than in individual parts of it.” (Central Bank of Iceland, Vol. 6, p. 4) Such risks include those resulting from systemically important individual financial institutions and credit and asset price cycles.
A committee was appointed by the head of the newly created Ministry to review the legislative framework and draft more stringent legislation. The new bill on the financial market was proposed to the Icelandic Parliament on January 29, 2010.Several reforms were incorporated in this bill that expanded the range of supervisory activities and intended to improve risk management and bank governance. (Ministry for Foreign Affairs) The FME was given increased discretionary powers, such as tightening credit limits for financial institutions and eligibility standards for potential investors. The bill also established a national credit registry containing data on all loans granted above a certain amount. The registry would store this information to monitor banks’ credit risk and households’ and firms’debt levels, allowing regulators an aggregate view to better monitor systemic risk. (Central Bank of Iceland, Vol. 5, p. 88). The bill also addressed many of the problematic practices that banks conducted in the years preceding the crisis, clarifying the rules that were already in place and proposing new restrictions. The bill covered such actions as lending against collateral of the bank’s own shares and the shares of other banks, lending to key personnel within the bank, and taking on large exposures. It also increased the provisions covering internal and external bank auditing.
Members of the board of directors of financial institutions were given greater responsibility and accountability, and tighter rules on remuneration, bonus systems, and severance agreements were established. In addition to this Act on Financial Undertakings, three other bills were presented to Parliament by May 2010 concerning Deposit Insurance, Investment Funds, and Insurance Activities.
Central Bank Act
An amendment to the Central Bank Act was passed in February 2009 that changed the CBI's governance structure from a three-member Board of Governors to a two-member Board consisting of one Governor and one Deputy Governor, both appointed by the Prime Minister. The amendment also established professional requirements for both positions. A Monetary Policy Committee was established as a decision–making body for domestic interest rate policies and exchange rate policies. The Committee is composed of the Governor and Deputy Governor, one senior CBI official, and two outside experts. (Central Bank of Iceland, Vol. 6, p. 58) These changes were spurred by a political controversy surrounding the head of the CBI from 2005 to 2009, David Oddsson, who also served as Prime Minister from 1991 to 2004.
Johanna Sigurdardottir, who became Prime Minister in February 2009, had made it a priority to remove the central bankers when she came to power, believing they were largely to blame for allowing the buildup of untenable debt. Mr. Oddsson refused to leave the CBI after Mrs. Sigurdardottir’s call for his resignation, so the Central Bank Act was passed by Parliament to forcibly remove him from his office. (Gilmore)
Promoting Intergovernmental Cooperation
Attempts have been made to improve the relationship between the CBI, the FME, and relevant ministries, as a closer collaboration between these institutions could help prevent some of the past deficiencies in the regulatory framework from arising in the future. In September 2010, the Committee on Financial Stability was established by an agreement signed by the Prime Minister, Minister of Finance, Minister of Economic Affairs, Governor of the Central Bank, and Director of the Financial Services Authority. The aims of the Committee are stated as follows:
The committee on financial stability shall enhance cooperation, facilitate the exchange of information and increase preparedness to maintain financial stability and coordinate crisis prevention efforts. The committee also induces more transparency regarding the institutions individual and shared responsibilities and areas for cooperation. (Central Bank of Iceland, August 2010) Although not a decision-making body, the Committee will hopefully increase cooperation within the government, facilitating policy making during times of financial trouble.
Judicial Decisions
A common practice of banks during the boom years was to offer loans linked to foreign currencies, such as the Japanese yen, allowing borrowers to take advantage of low international interest rates. However, beginning in 2008, the króna began declining in value and had lost more than a third of its value against these other currencies by the time of the banks’ collapse. The repayment costs to consumers for these loans became prohibitively expensive. In June 2010, Iceland’s Supreme Court ruled that car loans linked to foreign currencies, worth 186 billion Icelandic krónur, were illegal and later clarified that banks should use domestic interest rates when calculating charges. This ruling effectively passed the liability from households to the banks. (Ward) As the case stands as precedent, the decision strongly dissuades future banks from attempting such high-risk tactics, because they will be unable to transfer the risks to their borrowers.
Hopefully, the lessons from this crisis will entice the Iceland government and voters to insist that their government constantly regulate and supervise financial institutions, allowing a newly formed financial sector to prosper in a controlled and sustainable fashion
Explanation / Answer
ICELAND REFORM
Iceland being a small country, has a global financial footprint on the globe. The economics of the country in recent times saw a fall due to loop holes in the supervisory system. The FME to be precise was very carefree and casual when it came to matters of regulations and supervision that needed to be in place relating the banking system. The carefree attitude of the FME led to the financial crisi. This also had a mark on the minds of the icelandic people about their trut in the regulatory body.
The Prime Minister also admitted that it was the failure of the core ideology they had of an unregulated, free market. All the systems failed here, The FME, Politics, Media, The Icelandic people too.
The government has taken many measures or steps to make reforms by concluding two manjor investigation reports. One of them being that of Kaarlo Jannari, who suggested that number of ministries be reduced, Merging FME and CBI., introducing national credit registry, applying stricter rules on banks.
ACT OF FINANCIAL UNDERSTANDING
Ministry of Economic Affairs was introduced which dealt with both FME and CBI, more discretionary powers weregiven to FME, A bill was proposed. Many reforms were changed, many flaws were identified and rectified like banks credit risk. It also included issues of bank lending rates and how and which shares need to be given to whom and why?
Members of new system were moreresponsible now. Post this, many new bills were proposed/ presented to the parliment.
CENTRAL BANK ACT
This act was also ammended in Feb 2009. 2 instead of 3 membered board was made which has a governor and a deputy governor.
Promoting intergovernmental cooperation moves were made to strengthen and better the relationship of CBI,FME and other ministries. This committee was made with the aim of making all the ministries and bodies to work as a team and exchange information to work towards the same goal- CRISIS PREVENTION.
JUDICIAL DECISION: The car loans that were given against foreign currency shooted up during repayment. After regulations were put to place in 2010, car loans were paid by domestic currency. Now the liability moved from customer to banks.
Lesson learnt from the crisis is that the government needs to keep an eye on the financial institutions and constantly supervise and regulate them. Finally have an overall control over them.