Iceland Regulators Mull New Rules as Capital Inflows Return

  • FSA expects clarity on new carry trade rules `very soon'
  • Says Iceland better prepared to withstand money inflows

Until recently, Iceland’s main concern was too much capital leaving the country. Now, it’s about too much of it coming in. 

Seven years after its biggest lenders collapsed under $85 billion worth of debt, the island nation’s financial watchdog says it is now working with the central bank and the Finance Ministry to ensure that hard-fought stability is maintained.

"Clearly, we need to be concerned about potential excessive inflows as well as excessive outflows," Jon Thor Sturluson, deputy director general of Iceland’s Financial Supervisory Authority, said in an interview in Reykjavik. "Inflows may be benign in the short term, but the long-term consequences of a buildup similar to what we saw prior to 2008 can be disastrous."

Iceland has raised its key rate three times since June, to 5.75 percent, as the island completes its economic resurrection and plans further to ease capital controls later this year. Economic growth is now faster than the euro zone average, and the central bank says inflation will exceed its target this year as wage growth soars.

By offering western Europe’s highest yields after Greece, Iceland is becoming a magnet for traders who borrow in low-rate currencies and then invest in high-rate economies. A similar inflow of capital was instrumental in causing the 2008 banking crisis. Since May, foreign investors have snapped up 44 billion kronur ($337 million) in Treasury debt, or about 24 percent of the outstanding stock.

Despite prudential supervision having been "increased dramatically," the FSA says new rules and regulations may be required to keep inflows in check and avoid another crash.

"The experience from other countries tells us that inflows, due to international capital transactions, can take many forms," Sturluson said. "The problem can manifest itself in individual asset markets, for instance. So it may become an issue for us to deal with."

The central bank is already readying legislation to deal with the growing capital inflow. While Sturluson declined to comment on the preparations, he said “we can expect a clearer picture on this very soon.”

The regulator also said that the stricter supervision and new rules that are already in place, including an early adoption of the net stable funding ratio, put the financial system in better shape to withstand the inflows. The watchdog is also much more vigilant now, Sturluson said.

“Both on a general level and a specific level, we are much better prepared for this," he said.

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