mar guðmundsson : iceland ’ s crisis and recovery – facts, comparisons, and the lessons learned speech by mr mar guðmundsson, governor of the central bank of iceland, at the institute of international and european affairs, dublin, 27 april 2015. * * * accompanying charts can be found at the end of the speech. chairman, ladies and gentlemen, it gives me great pleasure to speak here at the institute of international and european affairs in dublin about iceland ’ s crisis and recovery and some of the lessons that could be learned from this experience. this is not least because of our historical bonds and the affinity that i feel exists between our people, to which we can now add the common experience of being hard hit by the great financial crisis. it is well known that iceland was the first advanced country to experience a full - scale banking crisis during the autumn of 2008, when its three big cross - border banks failed. it was also the first advanced country to go on an imf programme. what is probably less well known is that at that point, iceland was already on its way into a recession after an unsustainable boom and serious overheating during 2005 – 2007 and a currency crisis in the first half of 2008. the banking collapse and the associated wealth loss and further currency depreciation made the recession significantly worse, of course, as did the recession that hit the global economy in the fourth quarter of 2008. that autumn, two separate but interrelated sub - stories of the recent icelandic saga converged in a tragic grand finale. the first story was related to iceland ’ s boom - bust cycle and problems with macroeconomic management in small, open, and financially integrated economies. this is a story that has played out many times around the globe, and many of its elements have been seen before in iceland. it might have been somewhat more extreme this time around, but it wasn ’ t fundamentally different. the second story was the rise and fall of three cross - border banks operating on the basis of eu legislation ( the european “ passport ” ). this story was much more unique, as it involved the first banking crisis in europe since the eu single market was formed in the early 1990s. let me turn first to the banking story. in a few years prior to the crisis, the banking system had expanded very rapidly, as you can see from figure 1, making it one of the biggest in europe relative to gdp. most of this expansion was cross - border, and

##financed domestic assets that could revert to foreign residents with the unwinding of these estates will amount to 25 % of gdp ( see figure 12 ). when considering the complication that this creates for iceland, you should bear in mind that it is partly because the resolution of the third - largest bankruptcy in the history of mankind is taking place in one of the smallest countries in europe. therefore, potential outflows amounting to 40 % of gdp might seek a speedy exit if we were to lift the capital controls tomorrow. if our relatively large fx reserves ( 30 % of gdp ) were our first line of defence, they would be wiped out completely, and then the exchange rate would give way, with potentially serious consequences for economic and financial stability in iceland. we are currently working hard on solutions to this problem, and such solutions do exist. from a logical standpoint, the solution must take the form of either a significant reduction before early exit or a secure longer - term holding period before the controls are lifted. i am coming towards the end of my talk and will have to leave discussion of the lessons learned for the q & a session. the list is long and includes the need to avoid policy conflicts in small, open, and financially integrated economies, to better regulate fx risk in domestic banking systems, to give up the dream of financial centres in small countries if they do not have access to credible and comprehensive international or regional safety nets, and to improve policy frameworks and tools in light of the experience that we have been through. in iceland, this process has gone past the talking stage : frameworks for monetary and financial stability policies have been improved, new prudential rules have been introduced, financial sector legislation has been amended, and supervision has been improved and strengthened. and there is more to come. thank you very much. bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches bis central bankers ’ speeches