Iceland Ruling May Save Banks $4 Billion in Losses

Friday, 17 Sep 2010 06:56 AM

 

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Iceland’s banks may be spared as much as $4 billion in currency losses after the country’s top court ruled they can charge higher rates on loans affected by a foreign-currency lending ban.

The decision allows the island’s lenders, state-created successors to banks that failed in 2008, to charge borrowing costs that track the central bank’s main rate instead of rates attached to loans originally indexed to foreign currencies such as Swiss francs or Japanese yen.

Without the option to charge higher rates, banks had faced losses of as much as $4.3 billion because of the krona’s decline, Finance Minister Steingrimur J. Sigfusson said on July 7. Yesterday’s Supreme Court ruling will limit those losses to about $370 million, Gunnar Andersen, the head of the country’s financial regulator said. Moody’s Investors Service on July 29 said it was considering downgrading Iceland’s debt to junk after the foreign loan ban, arguing the move could require a state bailout of the banks.

“This matter has had a greater effect on the economy than any other single factor,” said Valdimar Armann, an economist at GAM Management hf in Reykjavik, in an interview. “The uncertainty has been somewhat lifted with the ruling.”

Yesterday’s decision follows an appeal by a private borrower after the District Court of Reykjavik in July allowed Lysing hf, controlled by Deutsche Bank AG, to raise the rate on its loan. The Lysing case was the first to test the scope of the Supreme Court’s June 16 ban on loans indexed to foreign exchange rates that had left lenders liable for currency losses.

Corporate Uncertainty

Economy Minister Arni Pall Arnason said yesterday the option to charge higher rates will be extended to all mortgages and retail car loans affected by the June 16 ban. The ruling won’t apply to corporate loans, some of which he said aren’t affected by the June ban. The government plans to pass a bill on foreign loans in October, he said.

“If corporate loans” indexed to foreign currency “are found to be illegal at a later point, that might have a dangerous effect on the system,” Armann said. “What is clear is that any uncertainty for banking is bad, and the uncertainty has now been partially lifted.”

Foreign-currency indexed corporate debt stands at 841 billion kronur ($7.2 billion), the Economy Ministry estimates, citing the total book value at the country’s lenders. That compares with Iceland’s 2009 total economic output of $12 billion.

Yen, Francs

Iceland’s 2008 financial crisis was exacerbated by banks that borrowed in currencies such as the euro, Japanese yen or Swiss franc to take advantage of lower interest rates, and then repackaged the loans in krona before passing them on to clients. While foreign currency lending is permitted, indexing krona loans to foreign exchange rates has been banned since 2001 to protect borrowers with krona incomes.

Iceland’s central bank benchmark rate is 7 percent, compared with 0.25 percent in Switzerland and 0.1 percent in Japan.

Arion Bank hf, the successor to Kaupthing Bank hf, Islandsbanki hf, formerly Glitnir Bank hf, and NBI hf, formerly Landsbanki Islands hf, have said they will continue to fulfill the Financial Supervisory Authority’s 16 percent capital adequacy requirement regardless of the June ruling.

The interest-rate ruling will have a “good impact on the economic outlook,” central bank Governor Mar Gudmundsson told reporters in Reykjavik yesterday.

© Copyright 2014 Bloomberg News. All rights reserved.

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