mar guðmundsson : iceland ’ s recovery – facts, myths, and the lessons learned speech by mr mar guðmundsson, governor of the central bank of iceland, at the official monetary and financial institutions forum ( omfif ) city lecture, london, 28 january 2016. * * * accompanying figures can be found at the end of the speech. chairman, ladies and gentlemen, i would like to begin by thanking omfif for giving me the opportunity to speak to you here today in the city of london about iceland ’ s recovery. this is interesting for me because, for better and worse, the uk and iceland deeply shared some aspects of the financial crisis, and because the city of london has for decades been iceland ’ s international financial centre. but it also gives me great pleasure to see so many in the audience who have in various ways helped iceland over the years. today i will focus on the recovery from the crisis and the current challenges, including the task of lifting capital controls. but the recovery cannot be understood without an understanding of the nature of the negative shocks that hit iceland during the crisis. it is well known that iceland was the first advanced country to experience a full - scale banking crisis in autumn 2008, when its three big cross - border banks failed. it was also the first advanced country to go on an imf programme during the great financial crisis. what is somewhat 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 global recession that began in the fourth quarter of 2008. in autumn 2008, 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. all the usual suspects were present, including strong capital inflows fuelling a credit and asset price boom that subsequently turned into a bubble at the same time as the economy overheated and

an unsustainable external position developed, as could be seen in a double - digit current account deficit. and macroeconomic and prudential policies were not up to the task. quite the contrary : there was a policy conflict between monetary policy and the demand levers pulled by the government, and the risks inherent in capital flows, fx balance sheets, and credit and asset price booms were left under - regulated and insufficiently supervised. 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 was part of the first banking crisis in europe since the eu single market was formed in the early 1990s. this framework, along with the prevailing conditions in international financial markets that provided for ample and cheap credit, facilitated the cross - border expansion of the newly privatised icelandic banks. in less than five years, from the end of 2003 to mid - 2008, the combined balance sheet of these banks went from under two times gdp to almost ten times gdp, topping other small european countries with international financial centres, as can be seen on figure 1 : bis central bankers ’ speeches towards the end, around two - thirds of the combined balance sheet of the three cross - border banks was denominated in foreign currency. on the liabilities side, the share of fxdenominated debt was actually higher, as can be seen on the right side of the slide, with almost half of the financing in the form of fx deposits and other short - term fx financing. the fx part of the balance sheet therefore had a significant maturity mismatch. however, there was a very limited safety net of the type we have in a national setting, in the form of liquidity provision and lender of last resort ( lolr ) to back it up. it was an accident waiting to happen, and happen it did, with a vengeance, at the peak of the international financial crisis in autumn 2008, when there was a wholesale run on the fx financing of internationally active banks. after having done a post mortem on the failed banks, we now know, however, that they also had other ailments that would probably have done them in at a later stage, although the process might have been somewhat less disorderly. the combination of the macroeconomic imbalances, an unsustainable banking system, and the full eruption of the great financial crisis meant that iceland faced unprecedented