mar guðmundsson : preserving the credit of the sovereign through a financial sector meltdown – the case of iceland speech by mr mar guðmundsson, governor of the central bank of iceland, at the international monetary seminar 2013 “ sovereign risk, bank risk and central banking ”, organised by the bank of france, paris, 8 july 2013. * * * i would like to thank banque de france for inviting me to speak at this interesting seminar. this session is on resolving sovereign debt crises and the relative roles of the public and private sectors in that process. my comments will obviously be based on my own country ’ s experience during the financial crisis, which is a case of a sovereign debt crisis being avoided in spite of the meltdown of a large part of the financial sector and the country ’ s deepest recession since the interwar period. that result was achieved by relatively good fiscal position prior to the crisis, by a refusal – based on need rather than stubbornness – to rescue private cross - border banks with public money, and by on - going medium - term fiscal consolidation that was an important part of the economic programme developed in cooperation with the imf. the bottom line is that all sovereign obligations have been honoured ; the sovereign has maintained investment - grade credit ratings and market access. in order to distinguish between the parts of this story that provide lessons that are applicable to the rest of the world and those that do not, we need to get some of the facts straight, because to this day there are still several misconceptions floating around about what was done in iceland during the crisis. the collapse of iceland ’ s three cross - border banks in early october 2008 was the most noticeable event in the unfolding of the financial crisis. the combined balance sheet of these banks was 10 times iceland ’ s gdp ( see figure 1 ), and their combined bankruptcy, measured in terms of balance sheets, ranks second in size in the international history of corporate failures, only after lehman brothers. and this happened in a country that ranks among the smallest in the world! we are still dealing with the complications that this entails, as can be seen in our overblown and unbalanced iip and the controls on capital outflows. figure 1 source : central bank of iceland. bis central bankers ’ speeches before the collapse, the banking system had expanded very rapidly, growing in just five years from a combined balance sheet of less than 2 times gdp at the end of 2003 ( see figure

policy interest rate on february 10. the consumer price index for the beginning of february was published this morning and the change in it turned out to be fully consistent with the bank ’ s latest inflation forecast. developments in the next few weeks and the prospects ahead will determine the next step as regards interest rates. opposing trends are at work there and at present it is impossible to state in which direction or when the next step will be taken. it also needs to be underlined that if the current outlook turns out to be correct, the proposed construction programme in east iceland will gradually begin to influence the formulation of monetary policy. to conclude, i would like to reiterate that monetary decisions by the governors of the central bank of iceland are made after extremely careful consideration of a large number of indicators.