16 October 2015

Financial Stability 2015/2 published

Central Bank of Iceland
The Central Bank has published Financial Stability 2015/2. This issue of the Financial Stability report contains the customary analysis of households’ and firms’ position, as well as a discussion of the banks’ operations and operating environment. Also included are the results of the stress test on the three large commercial banks, carried out by the Central Bank and the Financial Supervisory Authority this past spring.

Financial Stability is issued in two volumes each year. Today’s publication is the latter volume for 2015.

It was initially planned to include an appendix containing an outline of the proposals submitted by the failed banks’ creditors, in which they explain how they plan to fulfil the authorities’ stability conditions, together with an assessment of the overall impact of potential composition agreements based on those proposals. It is not possible to complete the assessment of the exemption requests filed by the estates until complete data that could affect such an assessment are forthcoming. The Central Bank intends to publish a separate report containing the results of its assessment of the exemption requests on the balance of payments, monetary and exchange rate stability, and financial stability once its analysis is complete and has been presented to the Minister of Finance and the Parliamentary Economic Affairs and Trade Committee. A press conference will be held when the report is published.

Following are the initial words of Deputy Governor Arnor Sighvatsson in the report:

"By the end of 2015, the economic recovery will have been underway for five years. Over that period, most economic indicators and premises for financial stability have changed for the better. Public, private, and financial sector balance sheets have gradually normalised and are still growing stronger and more streamlined. Last year represented a rare situation in Iceland’s economic history, one featuring internal and external balance simultaneously: low inflation, a virtually non-existent output gap, and a modest current account surplus. Financial institutions generated profits under these conditions; their liquidity was ample, and their capital ratios rose.

Conditions have improved still further this year; however, already discernible are the first signs of an incipient output gap, which could cause economic instability and risk in the financial system further ahead. Of particular concern are developments in the labour market, rising real estate prices, and early indications of increased inflows of foreign capital. Risk has not yet become excessive, however, and there is still ample scope to respond to the situation that could be developing. In addition, the financial institutions’ strong capital position should render them highly resilient under strain. At the end of June, the capital ratio of the three large commercial banks combined was 26.6% of their risk-weighted assets.

The risk that is most important to address at this stage is not related to these factors, however. A large share of non-residents’ claims against residents are potentially volatile short-term claims but have been locked in by the capital controls since November 2008. These legacy problems are still in the process of being solved. Measures have been designed to address them, including composition agreements for the failed banks’ estates and an auction for owners of offshore krónur, which will offer offshore ISK holders the opportunity to choose between tying up their krónur assets for a long period or exiting the króna via the auctions. If these measures prove successful, capital controls could be lifted soon thereafter without undue risk."