The domestic asset markets have rebounded strongly in the past twelve months, with a surge in turnover and a rapid rise in prices. There are many signs that imbalances are growing quickly in Iceland’s asset markets, and uncertainty about the future has increased. Share prices have risen by 57% in the past twelve months and are relatively high by some measures. For instance, the asset price gap – the deviation of prices from long-term trend – is at its widest since 2008. Property prices have also risen sharply. The real rise in the capital area house price index was 11.6% year-on-year at the end of August: 10% for condominiums and 15% for detached housing. The number of properties advertised for sale fell 45% year-on-year in August, the average time-to-sale is close to its historical low, and a large share of homes sell at a premium on the asking price. The asset price gap in the housing market is now nearly 14%, its widest since 2008. Market prices have also risen in excess of determinants such as wages and construction costs.

The surge in property prices and housing market turnover has been a driver of household credit growth, which has gained pace in recent months, measuring 6.8% in real terms at the end of July, as compared with 4.3% at the end of April. There are signs that the quality of new mortgage loans is deteriorating, as loan-to-value and debt service-to-income ratios have risen despite the steep increase in property prices and disposable income. This could be because borrowers are refinancing less and taking on more debt. Rapidly rising asset prices concurrent with growing indebtedness gives cause for concern, as this pattern implies an increase in systemic risk.

The banks’ profitability has grown in tandem with the economic recovery and stronger GDP growth, and household and corporate arrears have declined. The banks’ non-performing loan ratios are now roughly where they were before the pandemic. In recent quarters, the banks have reversed a portion of the impairment recognised in 2020. As of end-June 2021, their impairment account stood at 1.34% of the loan portfolio, about the same as at year-end 2019, and had fallen from 1.84% since the end of 2020.

Despite strong growth in household lending in recent months, the banks’ liquidity is very strong. At the end of August, their liquidity in excess of the minimum required by the Central Bank totalled around 290 b.kr., an increase of 43 b.kr. year-on-year. Credit spreads on their foreign bond issues have remained low, and the banks have ready access to foreign credit markets. Their króna-denominated market funding has declined somewhat.

Operational risk associated with financial market infrastructure, particularly electronic retail payment intermediation, has materialised in several instances in recent weeks. It is essential that each and every operating entity examine the security of their systems and put in place appropriate contingency plans to ensure business continuity. It is also important to strengthen the framework for the system as a whole and coordinate action plans in response to increased risk in this area. At present, a large share of Iceland’s electronic retail payment intermediation is routed through foreign payment card infrastructure. Iceland needs to have in place a domestic electronic retail payment solution that is independent of international infrastructure. Such a solution could serve as a backstop or alternate route for the domestic retail payment intermediation system.