Was the Crash of an Icelandic Bank Icesave in the Netherlands Avoidable?

Was the Crash of an Icelandic Bank Icesave in the Netherlands Avoidable?

Was the Icesave fiasco avoidable?


This article analyses both the risk management aspects that were known to all market participants and the risk management regulatory framework which existed prior to the Icesave approval by the DNB in May 2009. The aim of this examination is to attempt to understand whether regulators and the DNB in particular depleted all their method and analysed thoroughly all information obtainable at the time of the granting of banking permission to Icesave in the Netherlands.

At the time of the implosion of Icesave the bank had more than 100,000 accounts and more than 1, 7B Euro deposited money, but according to Landsbanki’s plans before the Icesave set afloat it expected to take only about 400-500 M Euro by the end of 2008. It looks like the DNB could do little to prevent the explosive growth of Icesave in the first few months of its operations.

Recently a report requested by the Dutch Parliament was published by two academics, DeMoor-Van Vugt and Du Perron from the University of Amsterdam. The report presented all events leading to the nationalisation of Landsbanki (the mother bank of Icesave) in chronological ordern, and analysed the actions of regulators both in the Netherlands and Iceland related to the granting of banking permission to Icesave. The report was mainly focused on the legal aspects of granting the banking license, with examination of the European Passport regime and the home/great number country form.

By granting the permit, Icesave was included in Dutch place Guarantee scheme, although the home country (Iceland) was responsible for regulating the Landsbanki group. The Icelandic regulator chiefly looked into the Group level reports, which were regularly submitted and showed substantial liquidity buffers and withstood stringent stress tests.

The fact that the DNB granted the license provided the quality image to the bank. The authors stress that the DNB did not have the legal tools to prevent the granting of the license, but if it had been handled less favorably and more time spent analysing and asking tough questions, the whole disaster may have been prevented.

The most important recommendation of the report is that the European regulations should be significantly revised, to prevent a situation where a country produces the risk of failure of a financial institution (via a place protection scheme), but has little strength in regulating such institution.

The difference between Foreign Branch versus subsidiary explained

A branch of a foreign bank is obligated to follow the regulations of both the home and great number countries. Because the foreign branch edges’ loan limits are based on the parent bank’s capital, foreign edges can provide more loans than subsidiary edges. That was probably the main reason why Icesave has been launched as a branch and not a subsidiary.

The risk management framework prior the granting of a banking license to Icesave operations in the Netherlands

Now let’s move on from the legal to the Risk management framework which existed before the time of granting the banking license to Icesave.

Liquidity regimes are nationally based according to the rule of “great number” country responsibility (although in some situations, the task, though not the responsibility, of supervision of branches is delegated to the home supervisor).

The risk assessment method used by the DNB called FIRM, which is kind of a scoring cards form. On the basis of the FIRM score the DNB sets the risk profile of an institution, which can rule either to a light or heavy supervisory regime. A branch office of a EU bank has a very small risk profile according to this form because it can request funds from the mother bank in the EU[1].

According to this method the DNB supervises on liquidity and integrity risks, which were both assessed as limited. By that time, February- May 2008, the Basel II requirements already had to be implemented and Landsbanki was informed about the requirements.

Let’s have a look now at the liquidity risk of Landsbanki at that time.

The original Basel II accord did not include liquidity requirements and a document named “Liquidity Risk:Management and Supervisory Challenges” dated February 2008 was the main source in defining the liquidity risk framework.

In that document the following elements were highlighted: liquidity policies, stress tests, scenario analyses, contingency funding plans, setting of limits, reporting requirements and public disclosure

It is worth mentioning that one important differentiating factor across regimes is the extent to which supervisors assign detailed limits on the liquidity risk and insurance that edges should keep up. This is in contrast to an approach that relies more on reviewing and strengthening edges’ internal risk management systems, methods and reports.

The chief sentence is: the application of liquidity regimes on a local management or legal entity basis requires that each legal entity be sufficiently strong with regard to external shocks. This may require a pool of liquid assets to be held locally, or for each entity to have independent access to contingent liquidity lines.

This pool has been requested by the DNB from Landsbanki but only just before the Landsbanki collapsed (September 2008).

varied in liquidity regimes

Liquidity regimes are affected by policy choices made by national authorities relating to the desired resilience of edges to liquidity stress. Factors include those nationally determined such as insolvency regimes, place insurance guarantees, and central bank credit and collateral policies, including intraday, standing facility, or emergency liquidity assistance arrangements, in addition as the structure of the banking sector itself.

Communication between regulators

In the European Directive on Financial Stability a home country is obliged to contact the great number country in question in case of known deficiencies. Strangely enough, on request of the DNB to provide more explanation about the explosive growth of Icelandic edges and liquidity problems, the FME (Icelandic supervisor) replied in August 2008 as following: “.. Landsbanki’s business is healthy, capital levels are strong and it performs well in various stress-tests that the FME applies.” [2].

Role of the supervisors in analyzing the market trends

In the Basel document regulating liquidity management it was clearly stated that to protect local entities supervisors have a duty to help ensure the resilience of entities within their jurisdiction to protect local depositors.[3]

In the later document issued in September 2008 and named “Principles for Sound

Liquidity Risk Management and Supervision” there is more clear description of the role of supervisors with an emphasis on the comprehensive assessment of a bank’s overall liquidity risk management framework by the monitoring of a combination of internal reports, prudential reports and market information. The market information was a missing link in the examination of Landsbanki. The main European and Dutch edges had already withdrawn from Iceland by the end of 2007 as more reports came in suggesting that the Icelandic economy and edges grew very fast and the bubble might burst very soon. The Swap rate of Icelandic edges and specifically Landsbanki were very high in the interbank market. This method that counterparties have less trust with these edges than with other edges. It worth mentioning that the Swap rate of Landsbanki was very high, (see a graph in the attachment).

So consequently the market knew that something was wrong with the Icelandic edges, but supervisors it seems were unaware or seemingly ignored the market behaviour.

Challenges in Liquidity Risk Management and meaningful Risk indicators

In certain circumstances, firms may also confront challenges in transferring funds and securities across borders and currencies, especially on a same-day basis. For example, institutions operating centralised liquidity management may be dependent on foreign exchange (FX) swap markets.

For example, if the liquidity save of a bank in for example NL is transferred within a cross-border group to Iceland where the local entity faces a liquidity shock but the move fails to resolve the problem within the group, the local entity in NL is likely to come under harsh pressure and will have no liquidity buffer to prevent failure. In that event, depositors in NL are in a potentially worse position than before the move. If however the move succeeds in stemming the problem, and there is no reputational contagion, then depositors in Iceland would be better off and those in NL no worse off.

A bank also should design a set of meaningful risk indicators or KRI’s to clarify the emergence of increased risk or vulnerabilities in its liquidity risk position or possible funding needs. Such early warning indicators should clarify any negative trend and cause an assessment and possible response by management in order to mitigate the bank’s exposure to the emerging risk.

Early warning indicators can be qualitative or quantitative in character and may include but are not limited to:

o rapid asset growth, especially when funded with potentially volatile limitations

o growing concentrations in assets or limitations

o increases in money mismatches

o a decline of weighted average maturity of limitations

o repeated incidents of locaiongs approaching or breaching internal or regulatory limits

o negative trends or heightened risk associated with a particular product line, such as rising delinquencies

o meaningful decline in the bank’s earnings, asset quality, and overall financial condition

o negative publicity

o a credit rating downgrade

o stock price declines or rising debt costs

o widening debt or credit-default-swap spreads

o rising wholesale or retail funding costs

o counterparties that begin requesting or request additional collateral for credit exposures or that resist entering into new transactions

o correspondent edges that eliminate or decline their credit lines

o increasing retail place outflows increasing redemptions of CDs before maturity

o difficulty accessing longer-term funding

o difficulty placing short-term limitations (eg commercial paper).

In my opinion many of these KRI’s were in red during the approval period in first half of 2008.

On December 17, 2009, the Basel Committee on Banking Supervision (BCBS) issued two consultative documents intended to apply lessons of the financial crisis to strengthen bank capital and liquidity frameworks while harmonising cross-border supervisory approaches. The central purpose for these revisions is to emphasise the holding of higher-quality capital and widen the pool of risks it is to sustain.


It is certain that that the Icelandic authorities bear responsibility for the Icesave collapse, but also so do the Dutch and UK authorities for allowing Icesave to function in their markets without adequate regulation and supervision of its operations or an appreciation of the consequences of a collapse (despite the European passport rules that allowed Icesave to function in those markets).

The actual CDS spreads, the Basel II working rules on risk management that prescribes the DNB to do an integrated risk assessment, including Landsbanki and the FX exchange risk, the problems with the loans of Icelandic edges with the Luxemburg Central Bank, the different ‘warning’ reports on Icelandic banking by market participants and the without of reserves in the Icelandic Central Bank were all reasons enough to at the minimum take more than a formal procedural approach during granting the banking license to Icesave.

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Written by Boris Agranovich

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