Iceland Banks Seen Strong Enough for Free Floating Krona

Iceland’s biggest banks have now built up the foreign currency buffers needed to withstand a potential capital outflow as the government moves closer to unwinding krona controls, according to Standard & Poor’s.

The rating company rates the north Atlantic island’s three largest lenders BB+ with a positive outlook. The banks have been clawing their way back to financial health after their predecessors defaulted on $85 billion in debt in 2008, plunging the island into its worst recession on record.

Finance Minister Bjarni Benediktsson said in an interview this week that it was his “personal goal” to present a plan for the removal of the restrictions by the end of the year. The constraints are blocking investors and creditors from offloading as much as $6.6 billion in assets.

Analysis on the potential currency mismatch in both Arion Bank hf and Islandsbanki hf indicates that “they could survive, even if all this money would flow out on day one of the capital controls being lifted,” said Alexander Ekbom, an analyst for S&P in Stockholm, in a telephone interview. Landsbankinn hf is a “bit more constrained” because it still needs government exemptions to extend a 226 billion-krona bond, he said.

Bond Maturity

Landsbankinn and LBI hf reached an accord in May to extend by eight years to 2026 the maturity of the bond, contingent on the government granting capital control exemptions. The government has yet to respond. Extending the maturities is seen as key to easing the controls. The bonds that are part of the deal represent about 28 percent of the assets blocked from exiting the $15 billion economy.

The banks have been able to restore credibility by obtaining credit ratings and Iceland’s Treasury has re-entered international debt markets, paving the way for a transition into a free krona float, according to Ekbom.

“This indicates that if there are certain outflows from one type of investor you can replace that with access to others,” he said.

Iceland’s approach to dealing with the 2008 collapse has been praised by both the International Monetary Fund and numerous economists, including Nobel Laureate Paul Krugman. The country imposed capital controls to stop the depreciation of the currency and also allowed its banks to fail.

Dollar Bonds

Since then, Iceland has sold two separate $1 billion dollar-denominated bonds in 2011 and 2012. In July, the Treasury sold 750 million euros of six-year Eurobonds.

While it’s important for Iceland’s banks to have market access, there’s “no expectation” that they show they can finance themselves entirely on the rates offered in debt markets, according to Ekbom.

“They have such a high ratio of deposits and equity that their need to finance their balance sheets with market instruments is also limited,” he said. “If there’s no huge growth in the asset base then actually they don’t need to access the international markets at these high levels.”

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