ingimundur friðriksson : the icelandic economy and financial system in april 2008 presentation by mr ingimundur friðriksson, governor of the central bank of iceland, at a meeting of the board of directors of the norwegian financial supervisor, kredittilsynet, reykjavik, 24 april 2008. * * * it is a great pleasure for me to have been invited to speak to the board of directors and management of the norwegian financial supervisory authority at its meeting in reykjavik this week. there are good reasons for the norwegian supervisor to come into direct contact with both colleagues in the icelandic supervisory authority and with leaders of financial institutions in general. much has been written and said about the icelandic economy and financial system of late, some of it accurate, some of it not so accurate. for the outsider, it may be difficult to separate the accurate from the inaccurate. as requested, i will in my presentation give an overview of recent economic developments and prospects and then touch briefly on the icelandic financial system. economic developments and prospects as you know, iceland is one of the highest income countries of the world and one with a highly developed infrastructure and institutional framework. you may also know that iceland is prone to greater economic fluctuations than most or all highly developed economies. in the 1990 ’ s, the icelandic economy was deregulated and liberalised and that process was largely completed with the full privatisation of the icelandic commercial banks shortly after the turn of the century. the liberalisation of the economy did not reduce its characteristic fluctuations. we are now coming to the end of a period of very rapid expansion. it started back in 2003 when construction commenced of a large aluminium smelter in the eastern part of the country and an associated power plant. the overall size of this investment was equivalent to over 30 % of gdp in 2003, the year that construction started. it therefore gave a very large boost to the icelandic economy. in the latter half of 2004, the icelandic banks began to compete head on with the state housing finance fund ( hff ) which had traditionally been the main provider of mortgage loans to households. the banks ’ entry into the market was no doubt the result of the hff ’ s ambition to increase its market share in the provision of mortgage finance. the banks had normally provided only a limited share of mortgage finance. they were in that respect different from banks in many neighbouring countries which have traditionally provided mortgage loans and thus have a stable portfolio of such loans on their balance sheet

bank inspectorate which has been built from the ground up in the bank and is closely linked to some of the bank ’ s other activities, for example in regard to a joint database. parliament is currently debating draft legislation, which calls for the creation of a new supervisory institution, which would combine all supervision of financial institutions. i cannot deny that the central bank is opposed to these ideas for reasons i discussed at this venue last year, and i shall not go into the issue in any more detail now. however, since the government ’ s wishes in this matter became clear the central bank has co - operated wholeheartedly with the ministry of commerce in preparing the best possible legislation in this area and in securing the necessary link between the central bank and the new supervisory institution and also to ensure that the central bank will have all necessary opportunities to guard a sound and effective financial system. in some central banks, which do not have supervision among their responsibilities, such as in sweden and the united kingdom, much work has been put into defining the relevant tasks of the central bank. the central bank is bound to seek models in these countries when it becomes clear that the bank inspectorate will depart. european monetary union there are now 9 months until the member countries of the european union, which meet the requirements of the maastricht treaty and become members of the european monetary union, adopt a new currency, the euro. there is now little to suggest that this will not happen on january 1, 1999 and the european central bank will be established this coming july 1. the central bank has thought it necessary to follow these developments closely, not least in order to be able to analyze the impact on iceland and the options available to iceland in the new environment. in june 1997, the central bank released a report european monetary union, creation and impact. the bank will release interim reports on this issue as the occasion warrants. at this stage, it is premature to say what impact the monetary union will have on icelandic exchange rate policy or on the options iceland will face. i will, nevertheless, say a few words about the subject as it appears from the perspective of the central bank. the outlook is now that 11 countries will form the monetary union at the outset. these countries account for only 33 percent of iceland ’ s external goods trade. the initial impact will therefore not be nearly as significant as has been suggested in the domestic debate. only when the united kingdom joins the monetary union will more than one half of iceland ’ s goods