12 May 2008

Board of Governors' Press Conference Thursday May 8, 2008 - The Bank's assessment and an abbreviated translation of the main questions and answers

The Board of Governors' gave a Press Conference on Financial Stability Thursday May 8, 2008.

Here you will find the Bank's assessment, presented by the Chairman of the Board of Governors, and an abbreviated translation of the main questions and answers.

First the assessment, presented by Mr. David Oddsson, the Chairman of the Board of Governors:

"In the analysis published in Financial Stability 2007, the Central Bank of Iceland concluded that the financial system was broadly  sound. That has not changed. 

The chain of events that began in mid-2007 and its effect on the global financial markets were quite unexpected. Risk appetite yielded to risk aversion, and there is no end in sight to the uncertainty that surfaced as a liquidity squeeze and broad-based concerns about the economic outlook. The Central Bank did not expect the heavy weather to turn into the tempest that ensued; however, in Financial Stability 2007 the Bank warned that challenging  waters lay ahead."

See the whole assessment, as presented in Financial Stability 2008.

Board of Governors' Press Conference Thursday May 8, 2008 - an abbreviated translation of the main questions and answers:

Central Bank of Iceland:

Board of Governors' press conference, Thursday, May 8, 2008, following the publication of Financial Stability.


Question: There have been fluctuations in the foreign exchange market. Following the publication of first-quarter earnings reports, it has been established that Kaupthing, at least, has taken a position against the króna in the amount of 60 to 80 billion krónur in excess of their hedging of own funds, which gives Kaupthing 18 billion in gains on the króna alone. What do you think of this? Is this entirely appropriate, and how much might that have influenced the sudden depreciation of the króna?

Chairman of the Board of Governors, Davíð Oddsson: I don’t wish to give an opinion on whether Kaupthing’s positioning in excess of its most acute need was instrumental in this regard. We knew for a long time, of course, that the króna could depreciate, as we have said before. We expected it to happen somewhat later. The Central Bank has also said previously that it would be in favour of the banks’ hedging against exchange rate movements, but we have also emphasised to them that they should exercise moderation in doing so. We are considering such matters now, in the wake of these developments. I don’t think there is any reason to discuss it in more detail at the present time.

Question: In Financial Stability 2008, you state that the number of individuals and couples whose debt exceeds their assets has grown. In a situation like the present one – perhaps over the next six to twelve months – is there reason to be concerned about this group? There is so much general discussion about the banks, and so much concern about them, but much less is being said about households. Is there reason to believe that bankruptcy will increase among households under the conditions that are foreseeable over the next six to twelve months?

Chairman of the Board of Governors: As is stated in Financial Stability, households’ overall equity and debt position should be manageable if disposable income does not fall sharply. But as you imply, there is little doubt in our minds that specific groups could experience difficulties in the near future, and yes, there is reason to be concerned about them.

Question: Do I understand you correctly, that this group includes approximately 25 thousand people?

Chairman of the Board of Governors: Yes.

Tryggvi Pálsson, Director of the Financial Stability Department: We must bear in mind, though, that these are figures from 2006.

Question: Could the situation be worse, then?

Tryggvi Pálsson: We don’t have any figures for that. What we have presented are the most recent figures available to us.

Chairman of the Board of Governors: The situation has probably deteriorated rather than improved. And looking ahead, it is more likely to deteriorate still further than to improve because, as the Bank has stated previously, it is most likely that, if asset prices fall – and it is unlikely, given the general state of the economy, that disposable income will remain at the current level, let alone rise – it is more likely, unfortunately, that segments of the population will need to be careful, to say the least.

Question: In your last Monetary Bulletin, you stated that house prices were likely to fall by as much as 30% in real terms. That forecast wasn’t terribly popular, but perhaps that doesn’t affect the seriousness of the situation. Do you foresee that, if that forecast materialises and the outlook remains as it is now – I refer to that group of people who owe substantially in excess of their assets – that there is a wave of bankruptcy ahead, and perhaps even a recession in the housing market, which is already quite cool? Is there a danger that a bottleneck will develop in the economy because of a housing slump?

Chairman of the Board of Governors: This forecast, as you said, was not published because it would win any popularity contests, although we would like to make people happy as often as we can, just like anyone else. But it was our candid assessment of the situation facing us. And, as we have said, this assessment is not far removed from what happens in other countries – that real estate prices dip following a strong economic upswing. The Central Bank of Iceland’s forecast was actually around the average in terms of such trends. We are not forecasting a recession, and I would like to reiterate: of course, there is a risk when a household’s debt greatly outstrips its assets and the loans are high for this reason, and when it is not likely that disposable income will remain stable or rise. For some people, this can be a challenging situation.

Tryggvi Pálsson: Of course, it is obvious that if assets fall in value and debt rises, this will create difficulties for some people, especially in cases involving foreign-denominated loans with high debt service. These constitute 13% of households’ debt, while 80% are indexed, which shows how important it is for households that inflation be kept under control.

Question: A great deal has been said in recent weeks about the necessity of strengthening the Central Bank’s foreign exchange reserves. I don’t remember exactly how large they are now, but in the Central Bank’s opinion, what is the ideal amount by which to increase them over the coming weeks and months?

Chairman of the Board of Governors: In many respects, the Bank’s foreign exchange reserves are strong already, especially in terms of the criteria that have traditionally been used; for example, as regards contingencies concerning import coverage. In that sense, the foreign reserves have never been as strong as they are right now, but other criteria are used as well. It has emerged that the Government considers it appropriate to strengthen the foreign exchange reserves. That message has been communicated to the Central Bank, and naturally, we intend to respond to it. We have already begun preparations, but it is also our role to consider the terms. It is important not to forget that it is expensive to maintain foreign exchange reserves, especially under current conditions, because of the differential between the cost of borrowing and the maintenance of the reserves. This can add up to considerable amounts. If the Bank had gone to the market two months ago, for example, when risk premia were high, it is likely that the excess cost would have been about 35 billion krónur over the lifetime of a 2 billion euro loan. It’s important to consider that the amounts of money involved are significant, and that this is why it is appropriate and sensible that the Bank, as the representative of the Government, go to the market when terms are deemed acceptable. It is also the case that, if the Bank goes to the market on behalf of the Government at a time when terms are unacceptable, it sends the wrong signals to the market; it implies that something is seriously wrong and that the government concerned cannot to go to the market when it would prefer to. This is why we have been cautious, which I think is wise. Of course, we listen to the Government’s points of view, and we will comply with the requests made of us in the most sensible manner possible.

Question: Economics professor Thorvaldur Gylfason has said that it is necessary that the foreign exchange reserves cover the nation’s short-term debt. Do you agree?

Chairman of the Board of Governors: No, we don’t agree.

Question: Have you engaged in any discussions with central banks in Europe or elsewhere concerning some sort of currency swap agreements? If so, what is the status of those discussions?

Chairman of the Board of Governors: We have discussed a wide range of subjects and continue to be engaged in discussions with other central banks concerning the various issues at hand. But the Bank’s policy with regard to all such matters is that we don’t discuss them in public until there is reason to report on them formally, and there is no reason to do that at this time.

Question: With regard to strengthening the Central Bank’s foreign reserves, does this mean that you won’t take such a loan this year because market conditions are not good enough at present?

Chairman of the Board of Governors: No, it doesn’t. Market conditions have improved substantially. Conditions in secondary markets have improved steadily with every week that passes, but I am not saying that the terms appearing on computer screens are indicative of what would be offered to the Government. As we have stated often, the Republic of Iceland is debt-free, and I expect that the terms offered to it would be much better than what we see in secondary markets. And terms have continued to improve. I am not at all saying that such a loan would not be taken, but it is also the Bank’s policy to refrain from discussing such matters more than necessary until there is reason to make a public announcement.

Question: There are funds out there that have invested substantial amounts in the hope that our economy will collapse and everything will go downhill. We know that they are waiting for some sort of action from Iceland. Are you afraid that, as time passes since mention was first made of strengthening the foreign reserves, this will work against us? That these funds will lose faith that anything will be done and will swing into action?

Chairman of the Board of Governors: No, actually, I don’t think so. But of course, they would have preferred that their forecasts had been correct and would materialise. I think it is out of the question that the Icelandic economy will take such a downward turn. We see, for example, that the banks are publishing positive operating results and are adapting to the current situation. They have announced, in Iceland and abroad, that they can withstand quite a lengthy period of liquidity shortage in the market. But this is why it makes sense for everyone to be careful. Here in the Board of Governors of the Central Bank, we have the habit of doing our work quietly and then making announcements when there is reason to make them.

Question: Just the other day, an American expert was here, and Icelandic economists have agreed with his statement that we need to separate the banks’ commercial banking operations from their investment banking. Do you agree?

Chairman of the Board of Governors: Yes, I think you may find agreement in various places on that point. There have been cycles in theories of this sort through the years, but I expect that under circumstances like the current global situation, such theories receive more support than they would otherwise. It could well be quite sensible to separate operations more clearly.

Question: It’s our understanding that Fitch Ratings will be discussing our sovereign credit rating, and that they have said that strengthening the foreign reserves would enhance confidence abroad in the Icelandic financial system. And if we don’t do it, our sovereign credit rating could be lowered. Isn’t that bad for us? And is there a chance that you will announce some sort of measures related to strengthening the foreign reserves in the next few days?

Chairman of the Board of Governors: As I have said, we are not creating any expectations of the kind. Frankly, we think that some pretty daring statements have been made by various parties that should rather have followed our example and spoken with caution. Some of the statements I refer to have not been helpful. We don’t want to behave in such a manner. We choose to wait and make announcements when it is appropriate. This is the procedure that the Central Bank of Iceland follows, and it is not alone in doing so. It is the general practice among central banks to carry out their work carefully and quietly, and not with a lot of fanfare and noise.

Question: It is said that the Icelandic banks are too large. In Financial Stability, you state that it should not be problematic if they choose the operational arena that suits them. Does this represent the Central Bank’s position on the Icelandic banks’ moving their headquarters abroad?

Chairman of the Board of Governors: No, quite the opposite. The report contains support for the idea that the banks are considering the fact that Europe is a single market with free flow of four main elements – goods, capital, services, and workers – within the area, and that it should not matter where in that area banks are headquartered. Financial Stability refers specifically to certain countries in this context: in some areas, the domestic banks are strong and have operations elsewhere, whereas, in the Baltic nations, for example, there is little domestic banking activity but a strong presence of foreign banks that are headquartered in other countries. What we are seeing is that, all of a sudden, when liquidity contracts in the markets, the idea emerges that central banks are considered some sort of guarantee fund for banks, no matter how large they are. It’s a new development if banks are supposed to be able to expand at will and take the risk that they choose to take, and then the public, through the central bank, is believed to function as some sort of inexhaustible guarantee fund. Such a thing would not be considered seriously anywhere. It is not the role of the Central Bank as such. However, the Central Bank of Iceland wishes to – and should – promote monetary stability and the stability of the financial system.

Question: Last year’s issue of Financial Stability concluded, as this year’s issue does, that the financial system was broadly sound, well able to withstand possible shocks, and so on. In other words, the financial system is capable of carrying out its tasks in a methodical and efficient manner. But now the banks have more or less stopped lending, the residential housing market is cooling down, the real estate market is frozen, etc. Is the financial system carrying out its tasks in a methodical and – perhaps no less – efficient manner?

Chairman of the Board of Governors: There is no doubt that the financial system is showing signs of tightening in this respect. As such, it is adapting to external circumstances. As regards the real estate market, as you mentioned, it should be borne in mind that the market has been quite overheated, and the banks’ outstanding claims in the housing market are considerable. In that sense, it shouldn’t be viewed as a disaster if that situation unwinds a little. Of course, it is difficult for the banks’ customers if they must suddenly change their course as they have had to do now; that is, at first they were able to satisfy all demand, and then they must suddenly – and unavoidably – step on the brakes. It is very difficult for businesses and households alike to deal with this sort of fluctuation, but the banks are adapting to extremely unusual external conditions. Most of them are dependent on global markets, and fortunately, they have taken care to boost their liquidity enough to see them through a very long period without access to capital. They deserve praise for having responded so effectively back in 2006. Our Icelandic banks are in a position no different than that of foreign banks, in that a prolonged shortage of capital must prove difficult. It is not possible to maintain that our banks are worse off than others or have conducted themselves in a more irresponsible manner than other banks have. I think it’s necessary to do them justice on that score.

Question: In the Bank’s assessment (in Financial Stability), you state that it is necessary to minimise the probability of a financial crisis. How likely is it that a financial crisis will develop?

Chairman of the Board of Governors: The report states that a financial crisis would be extremely costly for the nation and that it is therefore desirable to do everything in our power to avoid one. Other central banks have done so, and the Central Bank of Iceland has taken steps, for instance, to improve the operating conditions for domestic financial institutions. It now provides liquidity amounting to 400 billion krónur per week, which is four times higher than just a short while ago. As other central banks have done, the Central Bank of Iceland has liberalised access to funding here in the Bank in order to ensure that external difficulties will not create unnecessary problems in our banking system. As Financial Stability points out, experience shows that a serious recession can be very costly. But financial institutions must not be absolved of all responsibility for their own operations. The primary, secondary and tertiary responsibility must lie with the banks themselves, before it is possible to seek assistance from publicly owned institutions such as the Central Bank.

Tryggvi Pálsson: Since you asked explicitly what the probability is of a financial crisis, international organisations have attempted repeatedly to quantify this. The International Monetary Fund, for example, publishes figures that they call financial soundness indicators, but even though numerous indicators are being measured and examinations are carried out of how many green lights there are, it is extremely difficult to determine how probable it is, or what percentage to assign to such a probability. It is not possible to calculate financial stability in that way. It is absolutely clear, from the experience we are gaining right now, for example, that confidence is a key factor. A bank’s trustworthiness must hold. We see, for example, in the case of Bear Stearns, that all of the figures looked just fine – liquidity and capital position – but credibility failed all of a sudden, and action had to be taken. So it will be late in the day before we can quantify the probability of stability or crisis.

Question: I don’t mean to harass you about foreign reserves, which seem to be widely embraced as a panacea in the current situation. You have mentioned the cost involved. It is conceivable that the Government’s credit and even its credit rating would deteriorate if such a loan were taken. It is uncertain how much better terms our banks would enjoy if the foreign reserves were built up. Isn’t it appropriate to consider other avenues first, without increasing the foreign exchange reserves?

Chairman of the Board of Governors: Most of the credit rating agencies have reported that a stronger Central Bank would be conducive to a more beneficial rating, both for the sovereign and for the financial institutions within it, so that I think sensible action should ultimately prove advantageous for the banking system and for the Government. As regards the financial institutions’ credit ratings, what you say is correct – that it is important for them to adjust to the problem and reduce their risk. But this takes time, and as you know without my itemising what they have done, they have taken a number of steps in order to adapt to the current situation. They have divested certain assets and operations that were burdensome and have improved their liquidity as a result. There are examples involving all of Iceland’s largest banks that have gone this route, but we should remember that when this “credit crunch” began last July, opinions were sharply divided about how long it would last. So there is nothing inappropriate about it if financial institutions – Icelandic or foreign – bide their time rather than selling off operations at a lower price than they might receive later, that they wait a while and see if the situation improves. Many forecasts predicted, for example, that the markets would rally after financial institutions reported their year-end operating results. But when the situation has lasted this long, it is clearly sensible to cut costs in all areas and reduce risk wherever possible, and our banks have been doing just that. Whether they have gone far enough in this direction is perhaps a subject for debate, but we hope that there has been ample time to consider the fact that there are measures that should be taken other than strengthening the Central Bank. I agree on that point. It is necessary to place strong emphasis on those measures.