## 1islea2023008

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### EXECUTIVE SUMMARY — Scope and purpose
- Technical Note assesses and recommends on the financial safety net in Iceland, covering:
  - institutional arrangements for recovery, resolution, and crisis management;
  - oversight of banks’ recovery plans;
  - legal regime for bank bankruptcy and resolution;
  - resolution planning by the authorities;
  - funding mechanisms to support resolution;
  - the deposit guarantee scheme; and
  - government authorities’ collective preparedness to deal with financial crises.
- Assessment summarizes findings of the FSAP mission undertaken during November 28-December 9, 2022.

### Context and regulatory framework — key observations
- Iceland is a member of the European Economic Area (EEA); EU financial regulation has been mostly adopted via transposition of European Directives.
- Adoption of EU frameworks exposes Iceland to transitional and structural challenges of the EU’s crisis preparedness and management framework.
- Identified weaknesses include:
  - escalation triggers in recovery plans;
  - guidance on the adoption of the failing or likely to fail (FOLTF) determination;
  - valuation in resolution;
  - bail-in playbooks for banks;
  - procedures and systems to ensure quick pay-outs to insured depositors by the Icelandic Depositors' and Investors' Guarantee Fund (TVF), and periodic testing of such systems.

### Financial sector structure and key statistics (year-end 2021 / 2022)
- Number of credit institutions under RA remit: eleven (including four commercial banks and five savings banks).
- No foreign banks operating in the country.
- Total assets in the financial system: roughly 450 percent of GDP (year-end 2021); in 2007 total assets were around 900 percent of GDP.
- Pension funds: 170 percent of GDP and about 45 percent of financial system assets.
- Combined assets of commercial banks: about 150 percent of GDP.
- Pension funds’ holdings and interlinkages:
  - hold 18 percent of the mortgage market and 25 percent of bank shares;
  - account for about 13 percent of total bank liabilities: deposits (3.5 percent of bank liabilities), bank bonds (7.25 percent of bank liabilities), bank equity (1.75 percent of bank liabilities);
  - about one half of domestic bonds issued by banks are held by pension funds.
- Market concentration:
  - three largest banks (Landsbankinn, Íslandsbanki and Arion banki) represent 95 percent of the banking sector and are classified as D-SIBs;
  - five savings banks have negligible market share (less than 1 percent of total assets of the banking sector).
- Funding composition and foreign exposure (end-2021):
  - deposits comprised about half of D-SIB funding;
  - 96 percent of deposits were held by Icelandic residents;
  - market funding comprised 28 percent of total funding;
  - holding of foreign-denominated bonds by commercial banks was below 2 percent of their total assets.
- Ownership:
  - State holds 98.2 percent of shares in Landsbankinn hf and 42.5 percent of shares in Íslandsbanki hf (following sale of 57.5 percent in early 2021);
  - Arion Banki hf is wholly owned by private investors;
  - seven pension funds hold 25.38 percent of Íslandsbanki’s capital and seven pension funds hold 41.63 percent of Arion bank’s capital.
- Capital and leverage:
  - Central Bank’s minimum capital requirement ranged between 17.8 percent and 18.9 percent as of year-end 2021;
  - D-SIBs’ capital ratios were 5-8 percent above the required level after adjusting for dividend payments planned for 2022;
  - D-SIBs’ leverage ratio was 13.8 percent at year-end 2021.
- Asset quality and pandemic effects:
  - at year-end 2021, 13 percent of corporate loans and 2 percent of household loans were classified as forborne;
  - household credit growth reached 10 percent by end-2021, raising household debt to 84 percent of GDP;
  - systemic risk drivers: high house prices, high household indebtedness, large share of indexed and variable rate loans, interconnectedness with pension funds.

### Recovery and resolution framework — findings
- Recovery planning:
  - requirements are comprehensive and well implemented;
  - recovery planning is reaching maturity in largest banks;
  - recommendation: FSA (CBI) should promote routine plan testing among the largest banks.
- Resolution regime:
  - for systemic banks, regime adheres to internationally agreed resolution standards, with bail-in as preferred resolution tool;
  - Resolution Act approved in 2020; further work needed to operationalize resolution tools and ensure operational continuity, separability, and identification of significant impediments to resolution.
- Crisis management institutional framework:
  - current framework lacks formal involvement of the MoFEA; MoFEA should be informed on resolution issues ahead of bank failure;
  - recommendation: set up a coordination body involving MoFEA to strengthen cooperation/coordination while preserving RA independence.
- Bank insolvency and liquidation:
  - legal regime for bankruptcy and liquidation of non-systemic banks is sound;
  - special proceedings to liquidate a financial undertaking exist, with FSA active role and effective tools for the liquidator;
  - under current frameworks, TVF’s main function is to pay out insured deposits.

### Resolution planning, resolvability and operational needs
- Resolution plans:
  - first version (April 2022) and an update (September 2022) approved for three D-SIBs; RA will work on Kvika Bank in 2023 and finalize plans for five savings banks in early 2023.
  - minimum content follows EU rules (Article 22 of Commission Delegated Regulation (EU) 2016/1075).
  - RA does not share full resolution plans with banks; recommendation: share summary of key findings and an annual letter with priorities.
- Resolvability:
  - statutory creditor hierarchy favors resolvability (deposit super preference; senior preferred debt below all deposits);
  - RA considers senior preferred debt qualifies as MREL until at least 2024; position to be reviewed after BRRD II implementation.
  - concerns: public participation (State stake) could complicate bail-in and affect sovereign creditworthiness; pension fund participation requires further impact assessment.
- Preferred resolution strategies:
  - three categories identified: (i) simple bail-in (preferred for three largest banks), (ii) mixed approach (sale plus bail-in), (iii) not resolvable (MREL recap = zero).
  - operational guidance needed for all tools (sale of business, bridge bank, asset segregation), separability analyses, and valuations.
- Bail-in playbooks:
  - banks should prepare annual validated playbooks covering governance, communication, instrument identification, procedural steps, and management information systems.
  - RA should develop internal bail-in playbook including valuation request templates, appointment of external valuers, and draft decisions/communications.
- Valuation framework: Rule 666/2021 implements European valuation regulations into Icelandic law.

### Resolution funding and loss-absorbing capacity
- MREL and banks’ capacity:
  - RA issued MREL targets; banks required to fulfil MREL from outset and have until January 2024 to meet requirements; existing capital and liabilities meet requirements today.
  - RA left default required recapitalization amount equal to minimum own funds requirement.
  - RA position: no need to levy market confidence charge on Icelandic banks at this time.
  - for adjustments of recapitalization amount, reduction "should never exceed 10 percent of total assets."
  - subordination requirements to be introduced in H1 2023 after BRRD II implementation; transitional regimes and individual extensions possible.
  - prospective deadline for BRRD II incorporation into EEA (for EEA-EFTA countries) "Most likely this deadline will be mid-year 2026."
  - CBI working with MoFEA to implement BRRD II into Icelandic law; process scheduled to be finalized in Q2 2023.
- Resolution fund:
  - established as separate department within TVF; had 28.7 billion ISK under management at year end 2022 (around 2.50 percent of total covered deposits─1,139 billion ISK).
  - minimum target of the resolution fund is 1 percent of insured deposits by year-end 2027; Iceland's resolution fund is already fully funded thanks to transfer by TVF.
  - RA can require special additional contribution up to three times the annual contribution; RA can postpone such contribution for up to six months if it would significantly harm a bank's liquidity or solvency.
  - RA may, with MoFEA approval, borrow from similar financing arrangements in other EEA member states.
- Assessment of sufficiency and concerns:
  - doubts on sufficiency of the resolution fund for D-SIB resolution; TVF financially stronger for small bank bankruptcies.
  - recommendation: establish a robust backstop (government credit line favored) and negotiate financing arrangements with other EEA resolution funds.

### Emergency Liquidity Assistance (ELA) — features and recommendations
- Key features:
  - ELA should be as short-term as possible; currency = Icelandic króna; interest rates set above prevailing market rates in normal times.
  - Solvency criterion follows ECB rule 4.1 of the “Agreement on emergency liquidity assistance” of 9 November 2020.
- Minimum collateral standards: legal certainty, credit quality, simplicity, market transparency and price availability, market liquidity; plain vanilla electronically listed bonds favored.
- Operational approach:
  - CBI favors constructive ambiguity on collateral to retain flexibility; banks prefer some clarity.
  - some central banks check collateral eligibility in crisis simulations during on-site inspections.
- ELA and FOLTF/resolution:
  - if applicant is FOLTF it would not qualify for ELA; only after bail-in decision can a bank be regarded as solvent and potentially granted ELA.
  - for bridge institutions partly/wholly publicly owned, CBI would likely require a government guarantee.
- Recommendations:
  - require liquidity restoration plan as part of ELA eligibility;
  - operationalize ELA (including collateral eligibility checks in on-site inspections);
  - set clearer rules on provision of liquidity after resolution and define public guarantee requirements.

### Deposit insurance (TVF) — institutional arrangements, funding and pay-out
- TVF status: private non-profit operating under Act 98/1999; main task is reimburse covered deposits (pay-box).
- Structure: three divisions — deposit division, securities division and resolution fund; overseen by the CBI.
- Funding levels and targets:
  - minimum target of TVF's deposit division is 0.8 percent of insured deposits;
  - current TVF funds represent 1.6 percent of covered deposits (before transfer of ISK 28.7 billion to the resolution fund, actual resources held by TVF had reached 4.2 percent);
  - Law does not specify a predefined actual target; amendment in July 2022 established members not paying contributions when funds exceed minimum target.
- Pay-out deadlines (current law / practice):
  - timeframe for customers to lodge claims shall not exceed two months;
  - repayments made within 3 months from CBI's opinion that an institution is unable to repay deposits;
  - repayment period can be extended three times for three months each, so period cannot exceed 12 months.
  - Observed gap: deadlines are too long vs international standards (seven days).
- Pay-box plus and least-cost test:
  - pay-box plus mandate subject to least-cost test could enable TVF funds to be used in transfers to healthy banks up to net liquidation cost, reducing fund costs and maintaining depositor access.
  - transposition of Directive 2014/49/EU (esp. Article 11.6) would facilitate introduction.
- Backup funding and reimbursement capacity:
  - credibility strengthened by backup funding arrangements if disbursement deadline reduced to seven days;
  - authorities politically reject a public backstop; market-only borrowing insufficient.
  - end-September 2022: non-systemic banks' deposits covered = ISK 71.6 billion; TVF assets = ISK 18.8 billion (ratio 26 percent). End last year, before transfer to resolution fund, that ratio was around 95 percent.
- TVF investment policy:
  - low-risk and diversified; expected liquid instruments: cash, deposits, sovereign bonds and treasury bills.
  - policy proportions: domestic government bonds 52-72 percent; government bonds with AA- credit rating (or better) 20-42 percent; BBB- (or better) 0-20 percent.
  - at least 72 percent of funds shall be invested in securities guaranteed by the Treasury of Iceland or foreign states.
- Exclusions from deposit protection include: deposits owned by financial undertakings and related companies; deposits relating to money-laundering convictions; deposits of State/municipalities; deposits not registered by name; deposits of certain pension fund accounts.
- Operational gaps:
  - TVF has not implemented IT/systems for single-customer view and has not periodically tested pay-out procedures via simulations.
  - TVF has no role/responsibility in voluntary liquidation initiated when assets exceed liabilities.

### Crisis preparedness, CMH and cooperation
- Crisis Management Handbook (CMH):
  - CBI completing CMH; scope includes crisis indicators, triggers, communication plan, contingency management, liquidity window rules, early intervention, ELA, FOLTF determination, and maintenance program.
  - CMH should be extended to resolution stage and approved by Governor as soon as possible; should be tested in full crisis-simulation exercise.
  - CMH should include a communication plan specifying authority leading communications.
- Business continuity and cyber preparedness:
  - CBI has a business continuity plan; parts tested in a cyber exercise that demonstrated operational coordination among systemically important banks, critical data center and CBI.
- Nordic-Baltic and European cooperation:
  - MoFEA and CBI members of Nordic-Baltic Stability Group; participation should be active and extend to EBA, ESMA, EIOPA fora.
  - recommendation to introduce borrowing arrangements with national resolution funds / deposit guarantee schemes.

### Legal and governance features
- RA located in CBI with functional independence; reports to Governor; has full access to CBI data (Article 5 in Rule 1733/2021).
- RA financing: annual charge based on balance sheet size; minimum yearly fee for small institutions = ISK 250,000.
- Decision-making since March 2022: all major resolution decisions are taken by the Governor of the CBI, including approval of resolvability assessments, resolution plans, MREL and execution of resolution actions following FOLTF decisions by FMEN after consultation with RA.
- Judicial interaction:
  - no ex-ante judicial approval required for interventions; RA decisions final at administrative level (Article 6 Resolution Act).
  - ex-post judicial review possible but RA decisions taken in good faith cannot be suspended.
  - exceptional court interaction for moratoria or winding-up claims.
- Legal safeguards and NCWO:
  - NCWO principle present: shareholders and creditors protected from losses greater than under bankruptcy; compensation available from resolution fund if worse off.
  - limited deviations from pari passu allowed with bail-in; practical impact limited due to deposit super preference.
- Legal protection for civil servants:
  - current case law and Article 23 of Act No. 50/1993 limit employer recourse for damages; recommendation to explicitly include legal protection for current/former members and staff of financial safety net decision-making bodies.

### Winding-up procedures and testing
- Winding-up process:
  - liquidation mainly at FSA demand if operating license revoked; also possible at undertaking’s board request if unable to meet obligations.
  - petition directed to District Court; judge appoints winding-up board (up to five people) assuming rights/obligations of board/shareholders.
  - liquidator can sell assets and transfer liabilities (P&A).
- Cross-border moratorium:
  - moratorium granted by Icelandic court applies automatically to branches in another EU Member State.
- Recommendation:
  - FSA should test winding-up rules and procedures via crisis simulation and approve internal guidance on supervision of winding-up operations and court interaction.

### Key recommendations (selected from Table 1 and text)
- Establish a coordination body on resolution issues involving the MoFEA. — Authority Responsible: CBI and MoFEA; Priority: H; Timeframe: NT
- CBI should hire more staff for the RA or transfer temporary resources to the RA. — Authority Responsible: CBI; Priority: H; Timeframe: NT
- MoFEA should specify legal protection for current and former members and staff of decision-making bodies of the financial safety net. — Authority Responsible: MoFEA; Priority: M; Timeframe: MT
- CBI (FSA) should develop guidance on escalation triggers in recovery plans and on testing recovery plan implementation. — Authority Responsible: CBI (FSA); Priority: M; Timeframe: MT
- RA should elaborate granular operational guidance on FOLTF procedures, valuation and application of all resolution tools. — Authority Responsible: CBI (RA); Priority: H; Timeframe: MT
- RA should provide guidance to banks to prepare bail-in playbooks. — Authority Responsible: CBI (RA); Priority: H; Timeframe: NT
- RA should assess financial capacity of the resolution fund across crisis scenarios and consider introducing a financial stability exemption to the 8 percent minimum bail-in requirement, subject to strict criteria. — Authority Responsible: CBI (RA); Priority: M; Timeframe: MT
- CBI should operationalize ELA, including assessment of collateral eligibility in on-site inspections. — Authority Responsible: CBI; Priority: M; Timeframe: MT
- MoFEA should introduce maximum reimbursement timeframe of seven business days and assess potential introduction of a paybox plus mandate subject to least cost test. — Authority Responsible: MoFEA; Priority: H; Timeframe: NT
- TVF should be provided access to adequate backup funding sources (MoFEA or CBI) and implement procedures/systems to ensure quick pay-outs and regularly test pay-out procedures via simulations. — Authority Responsible: MoFEA and CBI; TVF; Priority: H/M; Timeframe: NT/MT
- CBI should approve the CMH as soon as possible, widen scope to bank resolution stage, and test it in a full crisis-simulation exercise. — Authority Responsible: CBI; Priority: H; Timeframe: NT
- Icelandic authorities should actively participate in the Nordic-Baltic Stability Group and other European fora and introduce borrowing arrangements with national resolution funds / deposit guarantee schemes. — Authority Responsible: MoFEA and CBI; Priority: M; Timeframe: MT

*Source: EXECUTIVE SUMMARY and selected chapters (1islea2023008).*

### EXECUTIVE SUMMARY __________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Scope and Purpose
- This Technical Note assesses and makes recommendations regarding the different elements of the financial safety net in Iceland, including:
  - institutional arrangements for recovery, resolution, and crisis management;
  - oversight of banks’ recovery plans;
  - legal regime for bank bankruptcy and resolution;
  - resolution planning by the authorities;
  - funding mechanisms to support resolution;
  - the deposit guarantee scheme; and
  - government authorities’ collective preparedness to deal with financial crises.
- The assessment summarizes findings of the FSAP mission undertaken during November 28-December 9, 2022.

### Context and Regulatory Framework
- Iceland is a member of the European Economic Area (EEA); EU financial regulation has been mostly adopted, providing a relatively sound first layer of the financial safety net’s legal framework through transposition of European Directives.
- Adoption of EU frameworks also exposes Iceland to the transitional and structural challenges of the EU’s crisis preparedness and management framework.
- Identified weaknesses across policies, implementation rules and procedures include, inter alia:
  - escalation triggers in recovery plans;
  - guidance on the adoption of the failing or likely to fail (FOLTF) determination;
  - valuation in resolution;
  - bail-in playbooks for banks;
  - procedures and systems to ensure quick pay-outs to insured depositors by the Icelandic Depositors’ and Investors’ Guarantee Fund (TVF), and periodic testing of such systems.

### Financial Sector Structure and Key Statistics
- Number of credit institutions under the remit of the Resolution Authority (RA): eleven, including four commercial banks and five savings banks.
- No foreign banks operating in the country.
- At year-end 2021:
  - total assets in the financial system amounted to roughly 450 percent of Iceland’s Gross Domestic Product (GDP);
  - in 2007 total assets were around 900 percent of GDP;
  - pension funds held 170 percent of GDP and about 45 percent of financial system assets;
  - combined assets of commercial banks amounted to about 150 percent of GDP.
- Pension funds’ role and interlinkages:
  - hold 18 percent of the mortgage market and 25 percent of bank shares;
  - account for about 13 percent of total bank liabilities: deposits (3.5 percent of bank liabilities), bank bonds (7.25 percent of bank liabilities), bank equity (1.75 percent of bank liabilities);
  - about a half of domestic bonds issued by banks are held by pension funds.
- Market concentration:
  - three largest banks (Landsbankinn, Íslandsbanki and Arion banki) represent 95 percent of the banking sector and are classified as domestic systemically important banks (D-SIB).
  - five savings banks have negligible market share (less than 1 percent of total assets of the banking sector).
- Funding composition and foreign exposure at end-2021:
  - deposits comprised about half of D-SIB funding;
  - 96 percent of deposits were held by Icelandic residents;
  - market funding comprised 28 percent of total funding;
  - holding of foreign-denominated bonds by commercial banks was below 2 percent of their total assets.
- Ownership:
  - the State holds 98.2 percent of shares in Landsbankinn hf and 42.5 percent of shares in Íslandsbanki hf (following sale of 57.5 percent in early 2021);
  - Arion Banki hf is wholly owned by private investors;
  - seven pension funds hold 25.38 percent of Íslandsbanki’s capital and seven pension funds hold 41.63 percent of Arion bank’s capital.
- Capital and leverage:
  - Central Bank’s minimum capital requirement ranged between 17.8 percent and 18.9 percent as of year-end 2021;
  - D-SIBs’ capital ratios were 5-8 percent above the required level after adjusting for dividend payments planned for 2022;
  - D-SIBs’ leverage ratio was 13.8 percent at year-end 2021.
- Asset quality and pandemic effects:
  - at year-end 2021, 13 percent of corporate loans and 2 percent of household loans were classified as forborne;
  - household credit growth reached 10 percent by end-2021, raising household debt to 84 percent of GDP;
  - combination of high house prices and household indebtedness poses systemic risk, amplified by large share of indexed and variable rate loans and interconnectedness with pension funds.

### Recovery and Resolution Framework Findings
- Recovery planning:
  - recovery planning requirements are comprehensive and well implemented;
  - recovery planning is reaching maturity in the largest banks;
  - recommendation: the Financial Supervisory Authority (FSA) in the Central Bank of Iceland (CBI) should promote routine plan testing among the largest banks.
- Resolution regime:
  - for systemic banks, the regime adheres to internationally agreed resolution standards, with bail-in as preferred resolution tool;
  - Resolution Act approved in 2020; further work needed to operationalize resolution tools and ensure:
    - operational continuity and liquidity in resolution;
    - separability;
    - identification of significant impediments to resolution.
- Crisis management institutional framework:
  - current framework lacks formal involvement of the Ministry of Finance (MoFEA);
  - given MoFEA’s responsibilities for resolution decisions that may require fiscal resources, MoFEA should be informed on resolution issues well ahead of bank failure;
  - recommendation: set up a coordination body involving MoFEA to strengthen cooperation/coordination and develop more structured dialogue with the RA at the CBI while preserving RA independence.
- Bank insolvency and liquidation:
  - legal regime for bankruptcy and liquidation of non-systemic banks is sound;
  - there are special proceedings to liquidate a financial undertaking, the FSA has an active role, and the liquidator has effective tools to perform the liquidation;
  - under current frameworks, TVF’s main function is to pay out insured deposits.

### Deposit Insurance and Resolution Funding Findings
- Deposit Guarantee Fund (TVF):
  - should be strengthened in line with EU requirements of the Deposit Guarantee Scheme Directive (DGSD);
  - specific recommendations include:
    - reduce maximum deadline for disbursements to seven days from one year in current framework;
    - provide TVF legal access to adequate backup funding sources;
    - assess potential introduction of a paybox plus mandate subject to a least cost test.
  - actual funding level of the TVF was much higher than the minimum requirement of the DGSD; excess contributions were transferred to fund the resolution fund.
- Resolution fund and funding:
  - further assessment needed of the financial capacity of the resolution fund in different bank crisis scenarios and the need for a backstop;
  - introduce greater flexibility through a financial stability exemption for the 8 percent minimum bail-in requirement, subject to strict criteria.
- Emergency Liquidity Assistance (ELA):
  - recommendation: CBI should operationalize ELA, including assessment of collateral eligibility in the context of on-site inspections.
- Pay-out procedures:
  - TVF should implement procedures and systems to ensure quick pay-outs to insured depositors and regularly test pay-out procedures via simulations.

### Crisis Preparedness and Cooperation
- The CBI is completing a crisis management handbook (CMH) to specify procedural steps, responsibilities, and triggers in escalation during a bank crisis.
- Recommendations:
  - CBI should extend the CMH to the management of bank resolution and approve it as soon as possible;
  - CBI should test the CMH in a full crisis-simulation exercise;
  - CMH should include a communication plan for financial crisis specifying the authority leading communications;
  - authorities should intensify collective contingency planning and testing;
  - Icelandic authorities should actively participate in the Nordic-Baltic Stability Group and other European fora to facilitate borrowing arrangements with national resolution funds / deposit guarantee schemes.

### Key Recommendations (selected from Table 1)
- 1. A coordination body on resolution issues involving the MoFEA should be established. — Authority Responsible: CBI and MoFEA; Priority: H; Timeframe: NT
- 2. The CBI should hire more staff for the RA or could transfer temporarily some resources to the RA. — Authority Responsible: CBI; Priority: H; Timeframe: NT
- 3. The MoFEA should propose that the legal protection of the current and former members and staff of the decision-making bodies of the financial safety net is specified in the law. — Authority Responsible: MoFEA; Priority: M; Timeframe: MT
- 6. The CBI should develop guidance on escalation triggers in recovery plans. — Authority Responsible: CBI (FSA); Priority: M; Timeframe: MT
- 7. The CBI should develop guidance on the testing of recovery plan implementation. — Authority Responsible: CBI (FSA); Priority: M; Timeframe: MT
- 11. The RA should elaborate granular and operational guidance on topics such as procedures related to FOLTF, valuation and application of all the resolution tools. — Authority Responsible: CBI (RA); Priority: H; Timeframe: MT
- 12. The RA should provide guidance to the banks to prepare bail-in playbooks. — Authority Responsible: CBI (RA); Priority: H; Timeframe: NT
- 14. The RA should assess the financial capacity of the resolution fund in different scenarios of bank crisis and the need for a backstop; while introducing greater flexibility through a financial stability exemption for the 8 percent minimum bail-in requirement, subject to strict criteria. — Authority Responsible: CBI (RA); Priority: M; Timeframe: MT
- 15. The CBI should operationalize ELA, including the assessment of collateral eligibility in the context of on-site inspections. — Authority Responsible: CBI; Priority: M; Timeframe: MT
- 17. The MoFEA should introduce a maximum reimbursement timeframe of seven business days and assess the potential introduction of a paybox plus mandate subject to a least cost test. — Authority Responsible: MoFEA; Priority: H; Timeframe: NT
- 18. The TVF should be provided with access to adequate backup funding sources (MoFEA or CBI). — Authority Responsible: MoFEA and CBI; Priority: H; Timeframe: NT
- 19. TVF should implement procedures and systems to ensure quick pay-outs to insured depositors and it should regularly test its pay-out procedures by performing simulations. — Authority Responsible: TVF; Priority: M; Timeframe: MT
- 20. The CBI should approve the crisis management handbook as soon as possible, widen its scope to the bank resolution stage, and test it in a full crisis-simulation exercise. — Authority Responsible: CBI; Priority: H; Timeframe: NT
- 21. In the CMH, a communication plan for financial crisis (including specifying the authority in charge of leading that communication) should be drafted and approved. — Authority Responsible: CBI; Priority: M; Timeframe: MT
- 22. Icelandic authorities should actively participate in the Nordic-Baltic Stability Group and other European fora and introduce borrowing arrangements with national resolution funds / deposit guarantee schemes. — Authority Responsible: MoFEA and CBI; Priority: M; Timeframe: MT

*Source: EXECUTIVE SUMMARY (1islea2023008)*

### 10. The Financial Stability Council is a formal high level cooperation venue for public

### 10. The Financial Stability Council is a formal high level cooperation venue for public authorities in the field of financial stability.

### Institutional roles and mandates
- The Council is chaired by the Minister of Finance and the Governor is one of its members.
- Main tasks of the Council:
  - to formulate official financial stability policy;
  - to monitor economic imbalances, financial system risks and undesirable incentives that can jeopardize financial stability;
  - to evaluate the effectiveness of macroprudential tools.
- The Council relies primarily on proposals and analyses from the CBI.

### Central Bank of Iceland (CBI) responsibilities and internal committees
- The CBI focuses on:
  - assessing risks facing systemically important financial institutions;
  - identifying macro-financial imbalances;
  - securing safe and sound operation of payment and securities settlement systems.
- The CBI regularly analyses risks and threats to the stability of the Icelandic financial system to detect vulnerabilities.
- The CBI is equipped with adequate macroprudential instruments; decisions on their application are taken by the Financial Stability Committee (FSN).

- Financial Stability Committee (FSN):
  - Coordinates public response to threats to financial stability or events that could cause significant contagion or damage.
  - Chaired by the Governor of the CBI.
  - Members include: the Deputy Governor for financial stability, the Deputy Governor for monetary policy, the Deputy Governor for financial supervision, and three external members appointed by the Minister.
  - An appointed official from the MoFEA participates as a non-voting member with the right to address the meeting and present proposals.
  - Tasks include deciding which supervised entities, infrastructures, and markets are systemically important and assessing systemic risk and financial stability; comments on governmental proposals in this area.

- Financial Supervisory Committee (FMEN):
  - Founded to increase oversight and cooperation in the financial sector.
  - After the 2020 merger of the Central Bank and the former Financial Supervisory Authority (FME), the Committee's role was amended but it remains the coordinating unit of authorities in a financial crisis.
  - Composition: the Deputy Governor for Financial Supervision, the Deputy Governor for Financial Stability, and three experts in financial market affairs appointed by the MoFEA for a term of five years.
  - The Governor chairs FMEN when the Committee takes decisions concerning systemically important financial institutions’ equity, liquidity, and funding.

- Financial Supervisory Authority (FSA) within the CBI:
  - Responsible for overseeing recovery planning by banks and for application of early intervention measures (EIM).
  - Since 2018 the FSA has been receiving recovery plans from Icelandic D-SIBs; other credit institutions started in 2020.
  - EIM can be applied if the bank does not comply with legal and regulatory provisions or if the CBI considers it likely the bank will not comply due to weak liquidity, increased hedging, increased defaults, or concentration of exposures.
  - Decisions on providing emergency liquidity assistance (ELA) are centralized in the CBI.

- Resolution Authority (RA):
  - Set in the CBI with adequate functional independence; reports directly to the Governor but works closely with the Financial Stability Division.
  - Has full access to information from the financial supervisory department and other departments of the CBI (Article 5 in Rule 1733/2021).
  - Information sharing processes are separate from other Bank processes.
  - Financing of the RA is done by charging the credit institutions under its remit; the annual charge is based on the size of the balance sheet except for small institutions that have a minimum yearly fee of ISK 250,000.

### Deposit guarantee and non-bank resolution
- Icelandic Depositors' and Investors' Guarantee Fund (TVF):
  - A private non-profit institution operating under Act 98/1999 on Deposit Guarantees and Investor Compensation Scheme and subsequent amendments.
  - Main task: reimburse covered deposits in a bank bankruptcy (pay-box function).
  - Operates with three independent divisions: the deposit division, the securities division and the resolution fund.
  - Overseen by the CBI.

- No agency responsible for resolution of non-bank financial institutions:
  - Insurance companies, central clearing counterparties (CCP), pension funds or other non-bank financial institutions are not subject to the resolution framework.
  - These institutions (excluding pension funds) would be wound up through insolvency proceedings under CBI oversight in its capacity as financial supervisor.
  - For CCPs, the recent European resolution regulation will be implemented in Iceland in coming years.

### Post-2008 reforms and banking sector structure
- Since the 2008 financial crisis a complete overhaul of the prudential legal framework occurred, largely led by EU legal amendments transposed into Icelandic law (Directive 2013/36/EU (CRD), Regulation (EU) 575/2013 (CRR), and Directive 2014/59/EU (BRRD), with subsequent changes).
- Key reforms included:
  - Greater demands for bank capital in terms of quantity and quality to meet capital adequacy ratio and a leverage ratio.
  - Tightened rules on liquidity and funding.
  - Introduction of the Supervisory Review and Evaluation Process (SREP) allowing supervisors to make specific demands on institutions, including special capital demands.
  - Revamped rules on risk management, increasing independence of risk units.
  - Strengthened supervisory authority with additional staff, technical resources, and powers (e.g., restrict activities, revoke licenses, assess and oversee qualified holders).

- Banking sector characteristics (14 years after the financial crisis):
  - Returned to basics with moderate loan to deposit ratios, simple asset and liability structures, traditional business models, and relatively small refinancing risk in foreign currency (FX).
  - Before the crisis more than 60 percent of banks' balance sheets were foreign assets and liabilities.
  - Restructuring of banks' asset portfolios was largely completed in 2017; since then banks have mostly relied on core financial operations.

### Resolution framework: staffing, decision-making, and coordination
- Resolution Authority staffing and capacity:
  - Current RA staff consists of two individuals; initial budget included three full-time equivalent staff.
  - This staffing level is insufficient to achieve required tasks, especially drafting policies and adding granularity to resolution plans.
  - The CBI should hire more staff for the RA, informed by experiences of other small European jurisdictions (Cyprus, Malta, Latvia, Lithuania and Estonia).

- Decision-making since March 2022:
  - All major resolution decisions, both ex-ante and ex-post, are taken by the Governor of the CBI.
  - This includes approving resolvability assessments, resolution plans, minimum requirement for own funds and eligible liabilities (MREL), and execution of resolution actions following a failing or likely to fail (FOLTF) decision taken by the FMEN after consultation with the RA.

- Role of the Ministry of Finance and Economic Affairs (MoFEA):
  - The Minister must approve application of financial stabilization tools and resolution decisions that can have a direct effect on the Treasury or systemic effects; this competence is linked to the use of public funds.
  - The Minister must approve RA decisions to borrow or lend funds to a similar financing entity in one or more EEA countries.
  - The MoFEA attends FSN meetings in an observatory capacity.

- Coordination proposals:
  - Establishing an interagency committee or board focused on resolution issues would facilitate coordination and structured dialogue between agencies (including the CBI and the MoFEA) without changing resolution responsibilities.
  - Participation of institutions likely to be involved in resolution (CBI, MoFEA, securities market authority) is recommended, given possible use of the resolution fund, public money, and the deposit guarantee fund.
  - Operational guidance for regular information requests by the MoFEA to the RA could strengthen cooperation; guidance could be set in law and include templates and clear reporting lines.

### Legal features of the resolution framework
- Legal safeguards and NCWO:
  - Key Attributes safeguards are in place; shareholders and creditors are protected from incurring losses in resolution greater than under bankruptcy proceedings (NCWO principle).
  - If left financially worse off, they are entitled to compensation from the resolution fund.
  - Resolution powers should respect hierarchy of claims; limited deviations from "pari passu" treatment of creditors are allowed when using bail-in, though practical use is negligible due to deposit super preference.

- Judicial involvement:
  - No ex-ante judicial approval or review of interventions is required or prescribed in the Resolution Act; RA decisions cannot be suspended or reverted by Courts.
  - Article 6 of the Resolution Act: decisions made by the RA are final at an administrative level with no appeals to other administrative authorities.
  - Ex-post judicial review is not restricted to the legitimacy of intervention measures, but resolution decisions taken by the RA in good faith cannot be overturned or suspended.
  - Exceptional court interaction: if a bank seeks moratoria or winding-up claims are filed, a court decision is required; the RA can request postponement of court proceedings against a bank in resolution if necessary for adopted resolution measures.

- Legal protection for civil servants:
  - Icelandic "rule of employers' liability" (case law from mid-1930s) and Article 23 of Act No. 50/1993 limit employer's recourse for damages toward employees; rule applies to public sector.
  - Recommendation to explicitly include legal protection for civil servants in legislation, specifying protection for current and former members of decision-making bodies and staff (including agents and advisors) across all institutions in the financial safety net.

### Bank insolvency and winding-up procedures
- Winding-up of a financial undertaking:
  - Estate cannot be liquidated according to general rules and must be wound up mainly at the demand of the FSA if it has revoked the operating license.
  - Liquidation can also occur at the demand of the undertaking's board if it can no longer meet obligations when they fall due and payment difficulties are unlikely to be alleviated.
  - A petition for winding-up is directed to the District Court where the undertaking is headquartered (Article 101 of Act 161/2002).
  - Upon court order, a District Court judge appoints a winding-up board of up to five people; the board assumes rights and obligations of the undertaking's board and shareholders.
  - Persons appointed must fulfil same eligibility requirements as the board of directors and managing director.
  - The liquidator can sell assets and transfer liabilities to another institution (P&A).

- Cross-border moratorium:
  - If a credit institution has its head office in Iceland, liquidation shall mean granting a moratorium.
  - If an Icelandic court grants a moratorium, such authorization automatically applies to all branches in another EU Member State.
  - Resolution Act and Bankruptcy Act do not differentiate between depositors/creditors from Iceland and from foreign countries.

- Hierarchy of creditor claims:
  - Tiered depositor preference: all deposits rank higher than ordinary claims, reducing risk of breaching NCWO in resolution.
  - Possibility that holders of senior preferred bonds could be subjected to bail-in while some pari passu creditors (e.g., derivative holders or commercial debt holders) might not be; but derivatives and "other liabilities" are small relative to issued debt and borrowed funds, so bail-in risk is considered very low.
  - In 2021 Iceland implemented a new category of senior non-preferred debt instruments; so far, banks have not issued any of this instrument.

### Staffing and governance recommendations (text boxed)
- The CBI should hire more staff for the RA; current staff seems insufficient for required tasks, especially drafting policies and granular resolution plans. The experience of other small European jurisdictions supports this recommendation.
- Establish a committee or board focused on resolution issues to facilitate coordination and structured dialogue between agencies (including CBI and MoFEA) while preserving RA independence.
- Explicitly include legal protection for civil servants in legislation, specifying protection for current and former members of decision-making bodies and staff (including agents and advisors); this provision should apply to all institutions in the financial safety net of Iceland.

*Source: IMF staff summary of chapter on Iceland financial stability and resolution frameworks (excerpts).*

### 33. The FSA should test the rules and procedures for the winding up of a financial

### 33. The FSA should test the rules and procedures for the winding up of a financial

### Winding-up testing and internal guidance
- The framework for winding up a financial institution "seems effective, it has not been tested yet."
- Recommendation: The FSA should test the rules and procedures for the winding up of a financial institution through a crisis simulation.
- Recommendation: Approve internal guidance to ease supervision of operations of a financial undertaking managed by a winding-up board and its interaction with the District Court.

### Planning for bank failures — A. Recovery Planning
- The authority distinguishes between submission of full recovery plans and simplified ones, applying proportionality in scope, frequency and intensity of supervisory engagement.
- Since 2018, the three D-SIBs—Arion banki hf., Íslandsbanki hf. and Landsbankinn hf.—have been required to prepare a full plan.
- Other credit institutions and investment firms were allowed to prepare a simplified one; these entities started this process in 2020.
- The FSA requires that a recovery plan covers at a minimum all the items listed in art. 2 of Regulation 780/2021.
- Recovery plans are updated regularly and on an ad hoc basis; the last revision was completed in spring 2022.
- The FSA considers recovery plans have sufficient quality, although they communicate to banks deficiencies or impediments.
- Findings from FSA reviews are available to the RA upon request, as well as other information the RA may require.

- Icelandic banks have liquidity and capital contingency plans with thresholds for triggering management escalation "well above regulatory requirements."
- Once banks trigger corrective measures of their contingency plans, they start interaction with the FSA; execution of the recovery plan is the second stage.

### Recovery planning — Recommendations
- The FSA should set thresholds to facilitate banks' decision-making on implementing recovery actions. Thresholds should be set at a level sufficiently above the point of likely supervisory intervention.
- Calibration of the recovery plan should be consistent and aligned with the institution's risk management framework and liquidity contingency plan. Escalation triggers need further work and discussion with banks.
- The FSA should develop guidance on testing recovery plan implementation (e.g., via dry runs). Banks should institutionalize such tests as routine practice.
- The authority should expect banks to ensure they have sufficient credible options to restore their capital and liquidity positions to appropriate levels in, or following, a stress.
- In assessing capacity of these options, firms should take into account the likely actions of peers in a stress.

### Planning for bank failures — B. Resolution Planning
- The RA approved the first version (April 2022) and an update (September 2022) of resolution plans for the three D-SIBs.
- The RA will work on resolution plan and resolvability assessment of Kvika Bank in 2023.
- In the first part of 2023, the RA plans to finalize resolution plans for the five savings banks; subsequently work on SaltPay, Indo Savings Bank and Fossar Markets Investment Bank (licensed in 2022).
- The RA decided to draft simplified resolution plans based on Article 11 of the Resolution Act for less significant or non-critical institutions.
- Minimum content of resolution plans prepared thus far follows EU rules (Article 22 of Commission Delegated Regulation (EU) 2016/1075 implemented into Icelandic legislation).
- Resolution plans are prepared on the basis of information the RA obtains from the institutions themselves; a national regulation lists information to be considered and replicates European regulation (EBA templates).
- The RA has indirect access to all bank data via supervisory and financial stability departments in the CBI, without restriction.
- The RA does not share the resolution plans with the concerned banks.

### Resolution planning — Recommendation
- The RA should share a summary of the key findings of the resolution plans with the concerned banks. A summary and an annual letter to the bank’s board with RA priorities are recommended to strengthen dialogue.

### C. Resolvability Assessment — Findings and actions
- For the three systemically important banks, resolution plans do not yet identify material impediments to preferred resolution strategies; this is preliminary as resolution planning has just started.
- If impediments exist and institutions cannot remove them, the RA is obliged to request action: review intra-group support agreements; prepare service agreements to guarantee continuity; set exposure limits; provide additional information; divest assets; limit or cease activities; etc.
- Statutory creditor hierarchy features that favor resolvability: senior preferred debt is ranked below all deposits, enabling senior preferred debt to be used to recapitalize a resolved bank without affecting deposit classes.
- The RA has stated that senior preferred debt qualifies as MREL until, at least, 2024. This decision will be reviewed after implementation of BRRD II.
- Concerns about public participation in bank ownership: a bail-in could wipe out State stake and create legal obstacles and political pressures impeding fast and effective resolution; a crisis of a public bank could affect sovereign creditworthiness.
- The RA considers significant pension fund participation in banks does not give rise to impediments to resolution, arguing total net worth of the pension sector relative to its stake would not trigger significant problems. Nevertheless, further work is needed to understand impact on pension funds and potential impediments to resolution execution.

### Resolution Tools — Preferred strategies and operational needs
- The RA has identified three categories of banks and preferred resolution approaches:
  - (i) Institutions where simple bail-in is the preferred and only resolution tool.
  - (ii) Institutions where a mixed approach is possible (part/all assets disposed plus bail-in for critical functions).
  - (iii) Institutions that do not satisfy conditions for resolution (MREL recapitalization amount = zero).
- The three largest banks are in category (i).
- Banks in category (ii) generally will have lower MREL requirements than category (i).
- Although current D-SIB plans envisage bail-in as preferred tool, operational guidance on other tools (sale of business, bridge bank, asset segregation) is necessary; preferred strategy may not be feasible and may need to be combined with other tools.
- Legal references: Article 3 of the Resolution Act (bridge bank or AMC may be at least partially publicly owned); Articles 45 and 50 permit RA to establish bridge bank or AMC.
- Work on separability is needed to operationalize transfer strategies. A separability analysis should include:
  - identification of proposed transfer perimeter;
  - separability assessment including interconnections and obstacles/costs;
  - assessment of market interest and capacity;
  - description of bank’s capabilities to provide accurate and timely information on the transfer.

- Bail-in playbooks (to be prepared by banks) should address:
  - governance and horizontal issues, communication arrangements, disclosure obligations, process for post-bail-in business reorganization plan;
  - processes and timelines to identify perimeter of bail-enable instruments and data generation for resolution scheme and bail-in execution;
  - detailed procedural steps for bail-in execution inside and outside the bank for every instrument type;
  - description of management information systems supporting processes.
- Playbooks should be validated by senior management and updated at least annually, taking RA feedback into account.

- The RA needs an internal bail-in playbook covering steps and procedures for executing a bail-in, including:
  - requests for valuation information (valuation 1, 2 and 3), templates, rules for on-site visits;
  - appointment of external valuer (pre-selected firms and draft contracts recommended);
  - preparation of bail-in execution based on updated liabilities report, additional data and compulsory exclusions;
  - preparation of drafts for all decisions and communications.

- D-SIBs have issued bonds in other countries and prospectuses include bail-in-ability clauses. The RA needs to identify contact persons in those authorities to facilitate recognition and prepare documentary needs; banks could provide legal assessments of potential impediments.

- Valuation framework: Rule 666/2021 of the CBI implements European regulations on valuation aspects (independence of valuer, methodology for valuing assets and liabilities, approach in preliminary valuations) into Icelandic legislation.

### Resolution Tools — Recommendations
- Further work is needed to assess impact on resolvability of pension fund and State participation in large banks' capital.
- Develop operational guidance for all resolution tools, including steps, procedures, templates and drafts to assist authority in applying those tools.
- Banks should prepare their bail-in playbooks.
- The RA should closely collaborate with the RAs of Ireland and Luxembourg to increase extraterritorial effectiveness of bail-in decisions.
- The RA should develop a practical set of rules on valuation in resolution, following documents published by the EBA and the SRB.

### Cross-Border Cooperation — Finding
- Currently no foreign financial entities or branches operate in Iceland and systemically important Icelandic banks have virtually no foreign entities or branches in EU/EEA or third countries.
- The CBI, including the RA, is not part of any cross-border supervisory or resolution colleges.

### Resolution Funding — A. Banks’ Loss-Absorbing Capacity
- The CBI approved the second version of resolution plans for the three D-SIBs and concurrently issued MREL targets.
- Banks were required to fulfil MREL requirements from the outset.
- The two publicly listed D-SIBs disclosed their first MREL requirements; Íslandsbanki disclosed the updated MREL as well.
- Banks have until January 2024 to meet regulatory loss-absorbing capacity requirements; their existing capital and liability stacks meet those requirements today.
- The RA does not expect banks to build additional loss-absorbing capacity buffers sufficient to meaningfully lower default risk on senior preferred debt in the near term.
- Subordination requirements will be introduced in H1 2023, after implementation of BRRD II. Transitional periods and interim targets will likely be introduced.

- The RA can take into account in determining MREL:
  - (i) preferred resolution strategy;
  - (ii) risk profile, funding model, and business model of each institution;
  - (iii) loss absorption amount and recapitalization amount (including the market confidence charge) and interaction with capital buffer values and additional capital requirements by the FSA (Pillar II);
  - (iv) subordination and determination of which liabilities can be included in MREL;
  - (v) deadlines for satisfaction of MREL requirements.

- The RA has left the default required recapitalization amount unchanged (equal to the minimum own funds requirement).
- On the market confidence charge, the RA's position is that there is no need at this time to levy it on Icelandic banks.
- For adjustments of the recapitalization amount, the authority can set a reduction of total risk exposure amount based on probable balance sheet size position of the financial institution that is FOLTF; this reduction "should never exceed 10 percent of total assets."
- As subordination requirements were not harmonized under BRRD I, the RA can determine subordination on an institution-specific basis.
- Subordination requirements under BRRD II will require banks in Iceland to decide whether to continue issuing senior preferred securities or shift to senior non-preferred issuance.
- The RA thinks senior preferred securities can be used to satisfy MREL at least until the deadline to comply with MREL requirements under BRRD II.
- For EEA-EFTA countries like Norway, Liechtenstein and Iceland, this deadline will be three years after incorporation of BRRD II into the EEA Agreement. "Most likely this deadline will be mid-year 2026."
- The CBI is working with the MoFEA to implement BRRD II into Icelandic law; process scheduled to be finalized in Q2 2023.
- To meet new subordination requirements, the RA will be able to extend deadlines for individual institutions and allow inclusion of senior preferred securities in MREL. Icelandic institutions currently comply with the requirement to apply the 3.5 percent. Also excluded liabilities of equal rank do not constitute more than 5 percent of the institution's own funds and eligible liabilities.

### Resolution Funding — B. Emergency Liquidity Assistance
- Eligible parties to ELA are domestic financial undertakings (credit institutions) with an operating license.
- To be eligible for ELA they must:
  - be solvent according to a predefined criterion;
  - be temporarily illiquid;
  - be unable to meet liquidity needs from an alternative source;
  - have sufficient collateral for ELA according to predefined minimum requirement standards;
  - present a recapitalization program that the CBI considers sufficient.
- Specific arrangement of ELA depends on characteristics of the emergency materializing.

*ICELAND — INTERNATIONAL MONETARY FUND.*

### 58. Some key features characterize the ELA. These include: (i) the liquidity support should be

### 1islea2023008 - 58. Some key features characterize the ELA. These include: (i) the liquidity support should be

### Emergency Liquidity Assistance (ELA): Key Features
- ELA should be as short-term as possible.
- Extension of ELA to a credit institution may not collide with the general ban on financing public sector projects.
- The currency of ELA is the Icelandic króna.
- Interest rates on ELA loans should be set above prevailing market rates in normal times (to incentivize replacement of the ELA).
- The solvency criteria for ELA is the European Central Bank's criterion (rule 4.1 of the “Agreement on emergency liquidity assistance” of 9 November 2020).

### Minimum standard requirements for ELA collateral
- Legal certainty: no doubt about the ability and legal right of the CBI to seize and liquidate the collateral after a counterparty default.
- Credit quality: collateral should fulfil internal minimum credit quality standards and credit quality should be reflected in the haircuts.
- Simplicity: plain vanilla electronically listed bonds should be favored.
- Market transparency and price availability: non-availability of true market prices requires approximation of asset values, which generally increases overall credit risk.
- Market liquidity: favor collateral with real and active market making.
- Government guarantees: as a rule the CBI would not request a government guaranty for ELA, but special circumstances could trigger government guarantees; a government guarantee would increase the value of poor-quality collateral.

### Operational approach, moral hazard, and collateral eligibility
- The CBI favors constructive ambiguity regarding collateral requirements to retain flexibility and minimize moral hazard.
- Banks prefer some clarity on collateral requirements to manage liquidity in crises.
- Some central banks check collateral eligibility in crisis simulations during on-site inspections to operationalize ELA.

### Risk controls, confidentiality, and additional measures
- Apply the same risk controls as in normal times (e.g., closeout-netting provisions, single agreement clauses).
- Possible additional, case-by-case risk controls include:
  - A detailed recapitalization plan evaluated by the CBI.
  - Increased surveillance of the ELA-recipient and assets provided as collateral.
  - Conditions ensuring all loss due to ELA falls on the credit institution's shareholders.
- Confidentiality: any ELA granted should remain confidential and secret for 1-2 years after ELA has been repaid in full; all decisions to extend ELA should be made public after the confidentiality period.

### ELA and institutions in resolution or FOLTF status
- If a credit institution applying for ELA is FOLTF, it would not qualify for ELA.
- Only after a bail-in decision by the Resolution Authority (RA) shall the bank be regarded as solvent and may then, if necessary, be granted ELA.
- For bridge institutions partially or wholly owned by public authorities, the CBI would more likely require a government guarantee for ELA.
- Granting ELA to institutions in resolution requires close co-operation with the RA and relevant government authorities and careful attention not to contravene the general ban on the CBI's financing of public sector activity.
- The CBI needs to further define requirements, especially on the need for a public guarantee, for liquidity after resolution.

### Recommendations on ELA
- Consider requiring a liquidity restoration plan as part of ELA eligibility criteria.
- CBI should work further on operationalization of ELA; during on-site inspections it should check eligibility of available collateral in crisis simulations.
- CBI should set clearer rules on liquidity after resolution; in principle ELA could be granted, but requirements—especially on the need of a public guarantee—are not completely defined.

---

### Resolution Fund: structure, funding, and capacity
- The resolution fund has been established as a separate department within the TVF.
- The fund had 28.7 billion ISK under management at year end 2022 (around 2.50 percent of total covered deposits─1,139 billion ISK).
- The minimum target of the resolution fund is 1 percent of insured deposits by year-end 2027; Iceland's resolution fund is already fully funded, thanks to a transfer made by the TVF.
- In accordance with Act no. 70/2020, the RA takes decisions on payments from the resolution fund.
- The permanent arrangement for funding the resolution fund was laid down with the passage of Act no. 48/2022.

### Supplementary financing and special contributions
- If the resolution fund's resources are insufficient, the RA is authorized to require banks a special additional contribution up to three times the annual contribution.
- The RA can postpone a special subsequent contribution in part or in whole for up to six months if the contribution can have a significant negative effect on a bank's liquidity or solvency.
- With prior approval of the MoFEA, the RA can decide that the resolution fund borrows from one or more similar financing arrangements in another EEA member state.

### Assessment of sufficiency and concerns
- Doubts are more likely on sufficiency of the Icelandic resolution fund (which would be used for resolution of D-SIBs) than on the financial capacity of the TVF (which would intervene in liquidation of very small banks).

### Recommendation on backstops
- A robust backstop for the resolution fund is needed given potentially large gross outlays.
- A government credit line would offer greater and more timely assurances than exceptional industry contributions and/or borrowing from EEA resolution funds.
- MoFEA and the CBI should negotiate financing arrangements with other EEA resolution funds.

---

### Public Recapitalization: legal framework and constraints
- Article 79 of the Resolution Act allows public recapitalization of a bank in extraordinary circumstances, but requires previous burden sharing from shareholders and holders of other eligible bail-in instruments of at least 8 percent of its total obligations (including own resources).
- Another regulation (Act 125/2008) authorizes MoFEA, under unusual and extraordinary financial market circumstances specified in the Act, to disburse funds to establish or take over a financial undertaking wholly or in part.
- Before recapitalizing a bank, the minister must consult the parliamentary committee managing the State's budget and obtain financial authorization through a supplementary budget law that goes through three debates in Parliament.

### Recommendation on public recapitalization rules
- Article 79 of the Resolution Act should define in more detail the extraordinary circumstances that justify using the government financial stabilization tool.
- Assess compatibility between Article 79 of the Resolution Act and Act 125/2008; MoFEA could merge the two Acts while observing EEA requirements.
- Introduce a financial stability exemption to the 8 percent requirement, subject to strict criteria, to ensure sufficient flexibility (as recommended by the 2018 Euro Area FSAP).

---

### Management and sale of public stakes in banks (ISFI)
- Icelandic State Financial Investments (ISFI) is a state body with an independent Board reporting to the Minister of Finance; established with Act 88/2009.
- ISFI main activities include:
  - (i) To manage the State's holdings in companies and undertakings.
  - (ii) To administer the State's communication with financial undertakings.
  - (iii) To oversee the execution of the State's ownership policy.
  - (iv) To exercise the Treasury's voting rights at shareholders' meetings of financial undertakings.
  - (v) To conclude agreements with boards of directors of financial undertakings with regard to, for example, equity contributions.
  - (vi) To make proposals to the Minister regarding additional funding of financial undertakings.
  - (vii) To assess and establish conditions for the restructuring and mergers of financial undertakings.
  - (viii) To make proposals to the Minister as to whether and when specific holdings in financial undertakings should be offered for public sale.
- When ISFI proposes a sale of State holdings, the Minister decides on all relevant elements and prepares a memorandum submitted to the Budget Committee and the Economic Affairs and Trade Committee of Parliament.
- The Minister shall consult the Central Bank of Iceland on bidder suitability and probable impact of a sale on foreign exchange market, foreign exchange reserves and liquidity in circulation.

### Recommendation on sale criteria
- Clear criteria on possible investors in the sale of state-owned banks should mitigate potential reputational risks for the State and comply with market practices and standards, taking into account Icelandic market peculiarities (especially size).

---

### Resolution Fund financial capacity—Box assessment
- The resolution fund will have 28.7 billion ISK at year end 2022 (around 2.50 % of total covered deposits).
- Minimum target in the Banking Union is 1 % of covered deposits.
- Idiosyncratic crisis funding sequence: (1) loss absorbing capacity of the bank (minimum bail-in of 8 % of total liabilities); (2) resolution fund (up to 5 % of total liabilities); (3) more bail-in or public money.
- If the resolution fund cannot meet that 5 %:
  - RA can require banks a special additional contribution up to three times the annual contribution.
  - RA may, with prior ministerial approval, borrow from similar financing arrangements in other EEA member States.
- If the crisis is systemic, standard resolution framework is difficult to apply; Article 79 (government financial stabilization tools) requires previous burden sharing of at least 8 % of total obligations, which may be contradictory in systemic scenarios and reduces resolution fund participation in funding.

---

### Deposit Insurance: institutional arrangements and funding
- Directive 2014/49/EU on Deposit Guarantee Schemes has not yet been adopted into the EEA Agreement; Iceland is not obliged to transpose it.
- Current legislation is mostly based on Directive 1994/19/EU; some amendments align Act 98/1999 with other European countries (e.g., coverage increase up to equivalent of EUR 100,000 in ISK).
- Governance of TVF (Act 98/1999): Board of Directors consists of four directors appointed by the MoFEA—two directly by the Minister, one proposed by the CBI, one nominated by Finance Iceland; four alternate directors appointed similarly; Board may hire a managing director.

### TVF funding levels and targets
- Minimum target of TVF's deposit division is 0.8 percent of the insured deposits of all licensed credit institutions.
- In practice, current TVF funds represent 1.6 percent of covered deposits (before transfer of ISK 28.7 billion to the resolution fund, actual resources held by TVF had reached 4.2 percent).
- The Law does not specify a predefined actual target; an amendment in July 2022 established that members of TVF do not have to pay more contributions when available funds exceeded the minimum target.
- Law should specify the target level and procedures for when the target is reached without needing a new Law to raise or stop contributions.

### Backup funding and reimbursement capacity
- Credibility of TVF could be strengthened by backup funding arrangements to tackle temporary liquidity shortfalls, especially if reimbursement deadlines are reduced to seven days.
- Authorities reject a public backstop politically; borrowing arrangements involving insured institutions alone would not be sufficient as sole funding source.
- At end-September 2022, non-systemic Icelandic banks' deposits covered by deposit insurance amounted to ISK 71.6 billion whereas TVF's assets amounted to ISK 18.8 billion (ratio of 26 percent). End last year, before transfer to the resolution fund, that ratio was around 95 percent.
- TVF is primarily intended for bankruptcy of the smallest banks; the resolution fund would face more challenging demands in a serious banking crisis.

### TVF investment policy
- Investment policy follows the spirit of Directive 2014/49/EU: invest "in a low-risk and sufficiently diversified manner".
- Expected liquid instruments: cash and deposits and sovereign bonds and treasury bills.
- Policy proportions:
  - Domestic government bonds: between 52-72 percent.
  - Government bonds issued by states with AA- credit rating (or better): 20-42 percent.
  - Government bonds issued by states with BBB- credit rating (or better): 0-20 percent.
- At least 72 percent of funds shall be invested in securities guaranteed by the Treasury of Iceland or foreign states.

### Pay-box function and exclusions
- TVF's deposit division becomes liable for repayment of covered deposits in three situations:
  - If a member institution is, in the opinion of the CBI, unable to repay deposits on demand or at due term.
  - If a member institution's estate is subject to bankruptcy proceedings.
  - In context of resolution under Act 70/2020, to avoid losses to covered depositors.
- If RA takes resolution action and deposits are affected, TVF shall pay a contribution to the RA from TVF's deposit division (with a cap set by Law); if TVF's contribution to resolution exceeds net losses it would have incurred under normal insolvency proceedings, TVF is entitled to payment of the difference by the RA.
- Deposits not protected include:
  - Deposits owned by financial undertakings and related companies.
  - Deposits relating to cases with a conviction for money laundering.
  - Deposits of a company in which a financial undertaking is the majority owner.
  - Deposits of the State, municipalities, their institutions and companies largely owned by public entities.
  - Deposits of operating companies of mutual funds and other funds on joint investment.
  - Deposits not registered by name.
  - Deposits of pension funds other than the client's share in the account of the depositor's pension savings account deposited with a deposit institution.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 78. The TVF has no role or responsibility in the event of a voluntary liquidation initiated

### 1islea2023008 - 78. The TVF has no role or responsibility in the event of a voluntary liquidation initiated

### TVF role in voluntary liquidation
- Under Act 2/1995, on Public Companies (applicable to TVF members), to initiate a voluntary winding-up process the assets of a company must exceed its liabilities.
- If a bank initiates a voluntary dissolution and its assets exceed its liabilities, the requirement for TVF's protection under Act 98/1999 is not satisfied.
- TVF is obliged to pay a depositor of a bank only in case the relevant bank is unable to make payments to the depositor.

### Deadlines for TVF disbursements and international benchmarks
- Current regulatory framework (regulation 120/2000, with subsequent amendments):
  - TVF's Board of Directors and the CBI decide the timeframe for customers to lodge claims against the fund; the timeframe shall not exceed two months.
  - Repayments shall be made to depositors within 3 months from the CBI's opinion that an institution is unable to repay deposits to its customers.
  - The repayment period can be extended three times, for three months at a time, so the period cannot exceed 12 months.
- Observed gap: Deadlines are too long compared to international standards and the EU framework (seven days).

### Pay-box plus mandate and least-cost test
- A pay box plus mandate, subject to a least cost test, can enable use of TVF funds for resolution up to the net cost it would have incurred in liquidation.
- Practical mechanics: transfer of deposits and good assets to a healthy bank with the deposit insurance fund covering the gap (subject to safeguards such as a ‘least cost’ test).
- Benefits: transferring assets at higher “going-concern” values reduces fund costs and maintains depositors' continuous access to funds, avoiding time-consuming reimbursement procedures.
- The transposition of Directive 2014/49/EU, and especially development of its Article 11.6, would facilitate introduction of that function.

### Public awareness and reputational issues
- All member companies of TVF are required by Article 16 of Act 98/1999 to publish on their websites information on:
  - their membership of TVF,
  - the scope of coverage,
  - which liabilities are excluded from coverage,
  - how depositors can make claims for repayments.
- Public awareness of the deposit insurance system in Iceland has not been measured.
- Negative public image of TVF (stemming from the 2008 crisis) makes implementation of governmental support measures to the TVF more difficult.

### Recommendations for TVF and authorities
- Introduce a maximum reimbursement timeframe of seven business days, in line with international best practices, and work on internal processes and systems to make that target achievable while improving public awareness of deposit insurance.
  - Note: TVF has not implemented procedures and systems (for example, IT system's capacity and procedural requirements to get regular information from banks on accountholders, including the use of single-customer view) and has not periodically tested pay-out procedures by performing simulations.
- The MoFEA and the TVF should set an actual funding target to be reached, considering total covered deposits of small and medium banks; that target could be modified with the evolution of those deposits. Implementing this approach does not require modification of a Law.
- Strengthen credibility of TVF by allowing access to backup funding sources. Credible backup funding sources would include credit facilities from the MoFEA, the CBI, or borrowing arrangements with EU deposit insurance systems; sole reliance on market borrowing would not be sufficient.
- The MoFEA should assess potential introduction of a paybox plus mandate subject to a least cost test. The transposition of Directive 2014/49/EU, and especially development of its Article 11.6, would facilitate introduction of that function.
- Carry out an assessment by an independent third party of the TVF's compliance with the IADI Core Principles for Effective Deposit Insurance Systems. Although management is aware of the Core Principles, no formal third-party assessment has been carried out.
- Reference: IADI Core Principle 15 is noted in relation to reimbursement timeframes.

### Crisis Management Handbook (CMH) and resolution preparedness
- The CBI is finalizing a Crisis Management Handbook (CMH); the final draft must be approved by the Governor of the CBI.
- CMH scope includes:
  - crisis indicators (solvency, liquidity, markets, supervision),
  - triggers and criteria for escalating response levels,
  - communication plan,
  - contingency management (participating members and communication issues),
  - the regular liquidity window for CBI transactions (quality requirements for collateral),
  - early intervention measures and recovery,
  - ELA (definition, information gathering, decision process and disclosure),
  - determination of the FOLTF of a bank (criteria, information gathering, decision process and communication plan),
  - maintenance program for the contingency plan (review frequency, responsible parties, simulations and rehearsals).
- CMH should be expanded as soon as possible to the phase of bank resolution.
- CMH will define guidelines and internal processes for responding to liquidity and solvency problems, set the CBI's response to crises (from short-term liquidity to ELA and early intervention), tackle collateral requirements, management of stigma, definition of stages and triggers.
- No formal national or system-wide financial crisis communication plan has been announced; an authority should be appointed to draft and lead crisis communication. The MoFEA should participate in decisions by the Financial Stability Council.
- The CMH's first version will end with a description of main decisions at the bank resolution stage, guidance on when an institution is considered FOLTF, and include internal guidance to assess the FOLTF decision sent to the resolution authority by the supervisory one.

### Emergency Liquidity Assistance (ELA) provisions in CMH draft
- CMH draft assumes design of a special data dashboard for one-point access to early warning / horizon scanning.
- The department of Market Operations will be involved together with the FSA and Financial Stability department in monitoring emerging liquidity problems among institutions that qualify for ELA.
- Proposal that CBI require banks to maintain a comprehensive and updated list of assets most likely to be used as potential collateral for ELA.
- ELA in FX will suppose a higher haircut on collateral to account for increased risks for the CBI.

### Business continuity and cyber exercise
- CBI has implemented a business continuity plan approved by the Governor covering alert levels, crisis management team, meeting places, teleconference directions, protection of critical services, communication plan, specialized plans (pandemic, security of information, IT operations and physical security), contact persons, etc.
- Parts of the plan were tested in a cyber security exercise led by the CBI with a scenario of a widespread ransomware attack that rendered ATMs, core banking systems, payment systems and cash distribution centers inoperable.
- Exercise demonstrated operational coordination between systemically important banks, the critical data center, and the CBI; coordination within the Central Bank; and secure communication pathways. From the CBI's perspective, the plans were fully operational.

### Nordic-Baltic Stability Group participation and simulation exercises
- The MoFEA and the CBI are members of the Nordic-Baltic Stability Group, which meets regularly to exchange cross-border financial stability information and holds simulation exercises.
- Participation by Icelandic authorities should be very active to share policies and guidance from larger countries; recommendation extends to participation in European fora (EBA, ESMA, EIOPA) via EEA agreement.
- The MoFEA, the FME and the CBI participated in the Nordic Baltic Stability Group joint financial crisis simulation exercise in 2019:
  - Scope: test crisis preparedness across countries; simulated crisis over two simulated weeks (two days in real life).
  - Scenario: abrupt and sizeable repricing of risk premia, tighter credit conditions, sharp fall in property prices, banks facing funding difficulties.
  - Outcomes: establishment of working groups on communication and collaboration tools; working group to analyze legal framework for cross-border information sharing among agencies.
  - Simulation exercises are to take place regularly and at least every 5 years.

### Recommendations for CMH and crisis cooperation
- In next iteration, CMH should provide further details on the resolution phase to be better prepared for bank failure.
- An authority should draft the comprehensive contingency plan for crisis and lead communication in a crisis. The plan should distinguish between potential events (resolution, liquidations, TVF's pay-outs, ELA) and provide tailored guidance on communication for these events.
- Participation of Icelandic authorities in the Nordic-Baltic Stability Group should be very active; recommendation extends to participation in all European fora and to introducing borrowing arrangements with national resolution funds / deposit guarantee schemes.

### Appendix I — 2018 Euro Area FSAP findings on crisis management (selected findings)
- In July 2018, IMF concluded first Euro Area FSAP, noting strengthened bank resolution framework at EU level but room for improvement.
- Key findings:
  - The banking union needs a more effective deposit insurance system; many national DISs are underfunded and lack effective backup funding. A common deposit insurance system for the Euro Area is missing.
  - A financial stability exemption is needed because the SRMR requires bailing in a minimum of 8 percent of total liabilities and own funds prior to access to the Single Resolution Fund or national public funds.
  - Fragmentation along national lines persists despite SSM and SRM; heterogeneous national insolvency regimes and divergent supervisory powers exacerbate outcomes and incentivize national solutions.
  - Many countries have not availed themselves of essential powers available under EU directives (e.g., public equity support and temporary public ownership; use of deposit insurance funds in liquidation proceedings).
  - Recommendation for a more unified resolution framework for small and large banks to include an administrative bank liquidation tool allowing the NRA to appoint a liquidator and commence proceedings irrespective of the public interest test.

### Appendix II — Two Key CJEU decisions on bank resolution (selected observations)
- CJEU ruling (June 7, 2017 resolution of Banco Popular by the SRB) validated elimination of certain fundamental rights (e.g., right to be heard, right to property) in interest of financial stability.
- CJEU confirmed that failure of a bank is not necessarily linked to insolvency and that provision of liquidity by the Single Resolution Fund must be to achieve effective application of resolution tools.
- The CJEU supported use of an extraordinary sale process (restricted contact with specific potential buyers) provided no buyer is unduly favored.
- On valuations: valuation carried out to determine unviability (valuation 1) loses relevance when ECB formally communicates failure to SRB; a final valuation 2 was not necessary for the sale of business tool.
- Governance: European Commission's role as permanent observer in SRB Executive Session is affirmed.
- CJEU ruling (May, related to claims filed in March 2018) clarified that resolution framework is an exception to normal insolvency and that actions by former shareholders seeking compensation that would frustrate resolution are not allowed to take precedence over financial stability.
- Effects of rulings:
  - Clarifies and favors sale of bank shares in resolution, avoiding future guarantees issued from resolution fund to facilitate bank sale.
  - Emphasizes that agile and efficient liquidations of medium and small banks require reform of ordinary insolvency procedures rather than expansion of the resolution regime.

*Source: 1islea2023008 (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1islea2023008.pdf_