Is the banking industry responsible for the economic disaster in Iceland?

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With about 320,000 people, Iceland has only about as many inhabitants as an average German city. Nevertheless, the island republic is among the richest nations in the world with one of the highest living standards. Iceland is a member of the United Nations, NATO and the European Economic Area, as well as many other international organizations. “Is the banking industry responsible for the economic disaster of Iceland?” Until the 80’s, Iceland was a more regulated economy with many interventions by the state. Since then, the Icelandic economy has been unbundled and increasingly liberalized. Since 1991, many state enterprises were successfully privatized. With the establishment of the European Economic Area between Iceland and other member…show more content…
Iceland's economic crisis shares a common bond with those that have infected other developed economies recently: all have banking systems heavily engaged in the practice of maturity mismatching. In other words, Icelandic banks issued short-term liabilities in order to invest in long-term assets, a practice which created funding gaps (i.e., liabilities less assets) of a given maturity for the three largest Icelandic banks -- Kaupthing, Glitnir, and Landsbanki. Thus, the banking system had to continuously roll over (renew) their short-term liabilities until their long-term assets fully matured. If an event arose whereby Icelandic banks failed to find new borrowers to continue rolling over their liabilities, they could face a liquidity crisis and, more importantly, spark the collapse of the Icelandic financial system; recent events have borne out this exact scenario. The Icelandic banking collapse resulted from two major causes: inadequate regulation of its central bank, and the inadequate size of their cash value of their banks. Regarding the first, the great error of the bank controller was to focus control efforts on the fight against inflation. This created an atmosphere conducive to speculators who had their money in Iceland, and who were attracted by the extremely high interest rates and a

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