## Executive Summary — _cr1291

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---

### Background and crisis overview
- In late 2008, Iceland experienced a deep financial and economic crisis after the global financial crisis; the three largest banks (Landsbanki, Glitnir and Kaupthing) collapsed in October 2008.
- Banks had grown to nearly tenfold of Iceland’s GDP by 2007:
  - gross international liabilities at 625 percent of GDP in 2007;
  - net external indebtedness exceeding 110 percent of GDP in 2007.
- Real GDP and domestic demand declined cumulatively by 10½ and 23 percent, respectively, during 2009–10.
- The exchange rate market ceased to operate; the króna depreciated sharply and asset prices were in freefall.

### IMF program and external support
- Fund approval and financing:
  - Front-loaded, 24-month Stand-By Arrangement (SBA) financing of SDR 1.4 billion (equivalent to 1,190 percent of quota).
- Bilateral financial assurances:
  - Total $2¾ billion from Denmark, Finland, Norway, Sweden, Poland, and the Faroe Island.
  - Nordic countries contributed $2½ billion, Poland $200 million, and Faroe Islands $50 million.
- Key program objectives:
  - Restore confidence in the króna (including through capital controls).
  - Put public finances on a sustainable path via multi-year fiscal consolidation consistent with debt sustainability.
  - Rebuild the banking system and implement private debt restructuring while limiting public absorption of banking crisis costs.

### Capital controls and fiscal stance (policy instruments)
- Capital controls introduced in late 2008 included:
  - Restrictions on capital transactions for residents and non-residents limiting króna/foreign exchange shifts.
  - Ban on conversion of króna denominated bonds and similar instruments to foreign currency upon maturity; proceeds required to be reinvested in króna instruments.
  - Requirement for residents to repatriate all foreign currency they acquire.
  - Exemptions for certain companies (major exporters and firms with large international operations).
  - Current account payments and inward FDI were released after a short period.
- Fiscal policy:
  - Initially accommodative to cushion the economy, then switched to consolidation.
  - Performance criteria set on the pace of public debt accumulation and on the central government’s fiscal balance.

### Program implementation, timing, and delays
- SBA approved November 2008 for November 2008—October 2010 (24 months).
- Reviews and disbursements experienced delays due to:
  - collapse of the government in early 2009 and formation of a new government;
  - need to secure financing assurances and to resolve Icesave-related issues;
  - uncertainties about the Icesave dispute and capital account liberalization strategy.
- Sixth and final review completed on time; bilateral partners extended outstanding loan commitments to end-2011.

### Icesave: background, dispute, and implications
- Icesave operations and scale:
  - Operated in the United Kingdom (from October 2006) and the Netherlands (from May 2008).
  - At Landsbanki’s collapse: over 300,000 UK customers with deposits of over £4 billion (€5 billion); in the Netherlands >125,000 customers and €1.7 billion of deposits.
  - All Icesave deposits were about 60 percent of GDP in 2008.
- Dispute timeline and outcomes:
  - First agreement: June 2009 (not implemented).
  - Second agreement: October 2009 approved by Parliament in December 2009; rejected in referendum March 2010.
  - Third agreement: December 2010 approved by Parliament in February 2011; rejected in referendum April 2011.
  - Dispute brought to EFTA Court and being settled legally.
- Implications for IMF program:
  - Icesave dispute affected financing assurances and delayed some program reviews.
  - Litigation risks identified: depositors’ claims on Old Landsbanki and challenges to the Emergency Law ranking depositors ahead of unsecured creditors.
  - Developments mitigating litigation risks:
    - October 2011 Supreme Court ruling upheld the Emergency Law.
    - EFTA Surveillance Authority finding in December 2010.
    - Landsbanki’s estate estimated to cover 100 percent of the Icesave deposits.
  - In December 2011, the Resolution Committee of Landsbanki made first partial payments covering close to one-third of recognized priority claims (ISK 432 billion).

### Outcomes and assessment
- Program completion: successfully completed, though with delays; supported by strong ownership and broad domestic consensus.
- Achievements:
  - Exchange rate stabilized.
  - Public finances largely put on a sustainable path.
  - Significant progress in banking system restructuring and private sector debt restructuring.
  - Fiscal outcomes (primary balance and gross public debt) better than initially projected.
- Remaining risks and priorities:
  - Public debt remains large; continued consolidation needed.
  - Capital account liberalization: timing trade-off — keeping controls too long could prolong distortions; too quick liberalization could deplete reserves and cause disorderly depreciation.
  - Financial sector: large nonperforming loans require further reduction via private sector debt restructuring.
  - Financial supervision: supervisory gaps to be addressed per FME action plan.

### Key lessons from the program experience
- Four principal lessons:
  1. Strong ownership of the program is critical.
  2. Social impact of fiscal consolidation can be eased by cutting expenditures without compromising welfare benefits, introducing a more progressive tax system, and improving efficiency.
  3. A bank restructuring approach that allows creditors to take upside gains but also bear part of initial costs limits public absorption of private losses.
  4. Temporary capital controls can be used as a last resort in crisis cases to prevent disorderly deleveraging and stabilize the economy.

*Prepared by the IMF interdepartmental staff team; report completed on March 9, 2012 (based on documents and data available at that time).*

---

### Banking sector downsizing, restructuring, and fiscal costs

### Size, concentration, and policy emphasis
- Total assets of the three largest banks declined to about 190 per cent of GDP by end-2010 (from close to 870 percent of GDP in 2007).
- Too-big-to-fail/too-big-to-rescue problem persists given the relative size of the three largest banks.
- Further scaling down of the new banks was judged not feasible because it would have required asset re-evaluation and limited business diversification, aggravating risk concentration.
- Policy emphasis: adopt a more stringent regulatory regime and more pro-active, intensive, and comprehensive supervision.

### Lending activity and credit conditions
- Despite stronger capital buffers, banks have not resumed core lending.
- Credit conditions remained very tight due to supply factors (risk aversion, deleveraging) and demand factors (debt workout, weak outlook, unemployment).
- Recovery in lending depends on further private sector debt restructuring.

### Housing Finance Fund (HFF)
- State made a capital injection equivalent to 2.1 per cent of 2010 GDP to bring HFF capital to about 2 percent of risk-weighted assets.
- Authorities assessing HFF capital needs to potentially restore traditional level (5 percent).
- ESA recommended measures bringing HFF in line with EEA state aid provisions by end-2011.

### Fiscal costs of bank support and restructuring (presented as component series)
- Write offs 1/: 13.0, 2.3, 3.9, 0.0, Total 19.2
- Securities lending 2/: 6.2, 0.0, 0.0, 0.0, Total 6.2
- Central Bank recapitalization: 6.8, 0.0, 0.0, 0.0, Total 6.8
- Commercial bank recapitalization 3/: 0.0, 2.3, 0.0, 0.0, Total 2.3
- Recapitalization of the House Financing Fund: 0.0, 0.0, 2.2, 0.0, Total 2.2
- Called guarantees of the State Guarantee Fund 4/: 0.0, 0.0, 1.8, 0.0, Total 1.8
- Public debt incurred with acquisition of assets: 11.5, 12.5, 0.0, 0.0, Total 23.9
- Central bank recapitalization (within public debt): 11.5, 0.0, 0.0, 0.0, Total 11.5
- Commercial bank recapitalization (within public debt): 0.0, 12.5, 0.0, 0.0, Total 12.5
- Gross fiscal cost of bank support and restructuring: 24.4, 14.8, 3.9, 0.0, Total 43.1
- Net fiscal cost of bank support and restructuring: 13.0, 2.3, 3.9, 0.0, Total 19.2
- Footnotes:
  - 1/ Capital transfers excluding the Icesave-related contingent liability of the government.
  - 2/ Securities lending contracts that failed after the bank collapse.
  - 3/ Retroactive interest paid to recapitalized banks to compensate for recapitalization delays.
  - 4/ A government guaranteed bonded liability of the Agricultural Fund taken over by one of the old banks prior to the crisis; guarantee called upon failure of the bank during the crisis.

### Private sector debt restructuring
- Pre-crisis private sector debt tripled to over 450 percent of GDP by end-2008:
  - household debt about 130 percent of GDP;
  - corporate debt about 340 percent of GDP.
- Progress:
  - Initially slow, accelerated toward end of program.
  - Authorities favored market-based voluntary workouts and legal framework strengthening to expedite out-of-court workouts, expand coverage, reduce “hold out” problems, and address information asymmetries.
  - After an October 2009 payment-smoothing accord, a comprehensive package agreed December 2010 with a sunset clause (mid-2011).
  - Pace accelerated after December 2010; a Supreme Court ruling (February 2012) may cause further delays.
- Asset Management Company option considered then dismissed due to delays, upfront state costs, and conflicts over asset valuation.

### Prudential regulation and supervision
- Legislation passed to rectify most regulatory failures; further reforms planned.
- Jännäri Report recommendations incorporated in Act No.75/2010 (Act on Financial Undertakings) approved June 2010.
- Recommended measures included strengthening FME powers, establishing a national credit registry, tightening large exposure provisions, and enhancing fit-and-proper requirements.
- Deposit insurance revision bill pending in parliament; new limited deposit guarantee arrangements to replace blanket guarantee.
- Supervisory architecture:
  - FME is unified supervisory agency but responsibility shared across Ministries; coordination risks exist.
  - Option discussed to merge FME and CBI; authorities decided to keep FME independent.
- Basel Committee Core Principle compliance:
  - FME completed a self-assessment mid-March 2011 that was independently evaluated; remaining BCP gaps require time and resources.

### Program conditionality on financial sector
- Early program: half of financial sector conditions were prior actions and structural performance criteria.
- Over time intensity and stringency were reduced and structural performance criteria eliminated to accommodate reform complexity.

---

### Fiscal policy, monetary policy, capital controls, and program outcomes

### Fiscal consolidation and public debt
- Fiscal consolidation amounted to over 9 percent of GDP during 2009–2011, with bulk achieved in 2009–2010.
- Composition: balanced between revenue increases (including social security contribution hikes) and expenditure cuts; social benefits safeguarded.
- Administrative reforms and cost-reducing measures in education and healthcare initiated.
- Medium-term consolidation path (Nov. 2009) envisaged overall improvement of the primary balance of 13½ percent of GDP during 2010-2012:
  - 5½ percent of GDP in 2010,
  - 4¼ percent of GDP in 2011,
  - 3½ percent of GDP in 2012.
- Third review (October 2010): target for general government primary surplus for 2011 and medium-term target lowered by ¾ percent of GDP.
- Sixth review (August 2011): medium-term target further lowered to support recovery.
- Public debt projected to reach 80 percent of GDP by 2016.
- Actual net direct fiscal costs of financial sector restructuring: slightly over 20 percent of GDP (smaller than initial SBA 2008 estimate of about 40 percent of GDP).
- Recapitalization costs for HFF and savings banks toward end of program below initial estimates.
- Fiscal framework reforms: New Local Government Bill passed September 2011; new Organic Budget Law intended for presentation by Spring 2012.

### Monetary policy, interest rates, and operations
- CBI interest-rate actions:
  - CBI increased policy rate by 600 basis points to 18 percent in November 2008 (prior action), reversing a 350 basis points easing in mid-October.
  - Loosening cycle in early 2009 as currency stabilized and inflation declined.
  - CBI cut interest rates to below 5 percent by end-2010 to support the economy and facilitate debt restructuring.
- Monetary operations improvements:
  - Strengthened liquidity provision, limits on short-term open-market operations.
  - CD issuance maturity lowered to 28-days (from 6 months); weekly auctions; volumes geared to absorb surplus liquidity.
  - Interest rate corridor narrowed from 500 bps to 300 bps at end-2009.
- Remaining transmission issues:
  - Excess reserves declined, but CBI could not anchor money market rates close to corridor center; money market remained dysfunctional.
- Inflation dynamics:
  - Inflation proved highly persistent; inflation expectations loosely anchored, indicating need to enhance post-program monetary framework.

### Capital controls: stabilization role and phased liberalization
- Capital controls helped stabilize the currency by preventing rapid unloading of large non-resident króna holdings and avoiding currency collapse.
- Directed investment into government bonds, facilitating budget financing and helping avoid sovereign financing crisis.
- Authorities’ conditions-based two-stage liberalization strategy:
  - Stage 1: liberalize offshore króna holdings.
  - Stage 2: liberalize onshore (largely resident) króna holdings.
- Progress toward liberalization aided by:
  - public finances on sustainable path,
  - strengthened banking sector,
  - risen international reserves,
  - regained sovereign market access.
- Factors in liberalization pace:
  - Offshore króna holdings remain large and pose potential pressure on currency and reserves.
  - Potential large pent up demand of residents to invest abroad.
  - Banking system remains vulnerable to liquidity and balance sheet shocks.

### Program outcomes and risks (quantitative results highlighted)
- Exchange rate: stabilized at a competitive level.
- Fiscal consolidation: primary balance improved by 6 percent of GDP during 2009–11.
- Banking sector size: assets about 200 percent of GDP (compared to around 900 percent of GDP pre-crisis).
- Household and corporate debt restructuring: advancing.
- Risk mitigation:
  - Authorities limited public absorption of bank restructuring costs.
  - Monetary/exchange rate policies with capital controls mitigated large capital outflows.
  - Litigation risk reduced by Supreme Court ruling upholding depositor priority; Icesave risks smaller but present.
- Remaining priorities:
  - Continue fiscal consolidation to secure sustainability.
  - Carefully sequence capital account liberalization to avoid reserve depletion and disorderly depreciation.
  - Reduce large NPLs through private sector debt restructuring.
  - Address supervisory gaps per FME action plan.

---

### Appendix I — Views of Icelandic officials and stakeholders

### Overall assessment and ownership
- Authorities and stakeholders broadly agreed with EPE findings and viewed 2008 SBA as achieving key objectives: stabilize exchange rate, place public finances on sustainable path, and restructure banking while limiting public absorption of costs.
- Fund flexibility in program design and timing fostered ownership; Fund technical assistance on fiscal matters seen as particularly useful.

### Monetary and fiscal roles before and during the crisis
- Officials acknowledged monetary policy contributed to imbalances (including carry trade) pre-crisis and that loose fiscal policy complicated monetary policy making.
- Heavy FDI and capital inflows complicated monetary policy.
- Some officials saw initial SBA interest rates as exceptionally high, increasing burden on highly indebted private sector and stifling recovery.
- Need for more instruments (macroprudential tools) emphasized.

### Supervision, resolution, and architecture
- Officials noted home-grown supervisory failures (e.g., lending to bank shareholders for equity buybacks) and limits of EU-level supervision given home licensing and national safety nets.
- Going forward priorities:
  - strengthen analytical capability of supervision,
  - provide adequate resources for FME and maintain its independence,
  - improve information exchange among institutions.

### Banking system restructuring and capital controls
- Achievements: banking system downsized, recapitalization completed, supervision strengthened.
- Remaining actions: speed up NPL restructuring; further strengthen bank balance sheets which operate in a protected environment given capital controls.
- Broad agreement on capital controls introduction at start of SBA; concerns about long-term distortions if controls kept too long.
- Recommended balanced, state-dependent liberalization contingent on:
  - macroeconomic stabilization (credible fiscal sustainability plan and declining inflation);
  - sound financial system;
  - adequate foreign exchange reserves.

### Medium-term challenges and policy priorities
- Key challenges: capital account liberalization, private sector debt restructuring, ensuring public finances sustainable.
- Officials link fiscal risks to capital control liberalization and view medium-term fiscal framework implementation as path to sustainability.
- Growth and structural policy emphasized: maintain recovery momentum and boost medium-term growth potential by addressing structural issues, including raising productivity.

---

### Selected quantitative highlights (as presented)

- Real GDP (row excerpt): 7.2 4.7 6.0 1.3 -6.8 -4.0 3.1 2.4
- Total domestic demand (row excerpt): 15.5 9.1 0.0 -8.6 -20.3 -2.3 3.9 3.7
- Private consumption (row excerpt): 12.7 3.6 5.7 -7.9 -14.9 -0.4 4.0 3.0
- Gross fixed investment (row excerpt): 34.4 24.4 -12.2 -20.0 -51.6 -8.1 13.4 13.8
- Unemployment rate (row excerpt): 2.1 1.3 1.0 1.6 8.0 8.1 7.4 6.3
- Consumer price index (row excerpt): 4.0 6.8 5.0 12.4 12.0 5.4 4.0 4.8
- Gross external debt (row excerpt): 284.5 433.5 605.9 564.7 266.5 289.7 250.4 204.2
- Central bank reserves (US$ billion) (row excerpt): 1.1 2.3 2.6 3.6 3.9 5.8 8.7 7.3
- Medium-term projections (Real GDP 2009–17 snippet): -6.8 -4.0 3.1 2.4 2.6 2.2 2.6 2.7 2.9
- Medium-term projections (CPI inflation snippet): 12.0 5.4 4.0 4.8 3.5 2.5 2.5 2.5 2.5
- Gross debt (projection snippet): 88.2 92.8 99.2 97.3 92.5 91.0 88.1 83.4 82.2
- Central Bank policy rate (period average) (row excerpt): 10.5 14.1 13.8 15.4 13.7 7.8 4.4 ...

*Source: _cr1291 — IMF staff report excerpt and appendices.*

### Executive Summary ......................................................................................................

### Executive Summary

### Background and crisis overview
- In late 2008, Iceland experienced a deep financial and economic crisis following the global financial crisis; the three largest banks (Landsbanki, Glitnir and Kaupthing) collapsed within a short period in October 2008.
- Banks had grown to nearly tenfold of Iceland’s GDP by 2007, with gross international liabilities at 625 percent of GDP and net external indebtedness exceeding 110 percent of GDP in 2007.
- Real GDP and domestic demand declined cumulatively by 10½ and 23 percent, respectively, during 2009–10.
- The exchange rate market ceased to operate; confidence evaporated, the króna depreciated sharply, and other asset prices were in freefall.

### IMF program and external support
- The Fund approved a front-loaded, 24-month Stand-By Arrangement (SBA) financing of SDR 1.4 billion (equivalent to 1,190 percent of quota).
- Bilateral financial assurances amounted to $2¾ billion from Denmark, Finland, Norway, Sweden, Poland, and the Faroe Island.
- Nordic countries contributed $2½ billion, Poland $200 million, and Faroe Islands $50 million (as noted in Fund documents).

### Objectives and policy mix of the 2008 SBA
- Key program objectives:
  - Restore early confidence in the króna by stemming its depreciation, including through the use of capital controls.
  - Put public finances on a sustainable path through multi-year fiscal consolidation consistent with debt sustainability.
  - Rebuild the banking system on a sound basis and implement private debt restructuring while limiting absorption of banking crisis costs by the public sector.
- Capital controls introduced in late 2008 included:
  - Restrictions on capital transactions for residents and non-residents limiting shifts between króna and foreign exchange.
  - A ban on conversion of króna denominated bonds and similar instruments to foreign currency upon maturity, with proceeds required to be reinvested in other króna instruments.
  - Requirement for residents to repatriate all foreign currency they acquire.
  - Exemptions for certain companies (major exporters and firms with large international operations) subject to criteria; current account payments and inward FDI were released after a short period.
- Fiscal policy stance:
  - Initially accommodative to cushion the economy, then switched to consolidation to put public finances on a sustainable path.
  - Crisis-related costs posed major risks; these were mitigated by authorities’ commitment and actions to limit absorption of bank restructuring costs by public finances.
  - Fiscal solvency concerns were addressed by setting performance criteria on the pace of public debt accumulation and on the central government’s fiscal balance.
- Fund financing aimed at shoring up low international reserves and strengthening investor confidence and external financing capacity.

### Program implementation, timing, and delays
- The SBA was approved in November 2008 for the period November 2008—October 2010 (24 months).
- Program reviews and disbursements experienced delays:
  - First review delayed following collapse of the government in early 2009 and formation of a new government; qualitative targets for end-December 2008 on changes in net international reserves and central government net financial balance (deficit) were missed, but subsequent indicative targets and cumulative performance criteria were met.
  - Further delays occurred to secure financing assurances and to resolve Icesave-related issues; the fifth review was delayed partly due to uncertainties about the Icesave dispute and to formulate revised capital account liberalization strategy.
  - The sixth and final review was completed on time; bilateral partners extended outstanding loan commitments to end-2011.
- Icesave context:
  - An agreement with the United Kingdom and the Netherlands provided for deposit insurance in foreign branches of Landsbanki to be covered by a loan to the Icelandic Deposit Guarantee Fund, guaranteed by the Government of Iceland; payments to deposit holders from the assets of the failed bank would decrease the outstanding amount.
  - In December 2011, the Resolution Committee of Landsbanki made the first partial payments to priority creditors, covering close to one-third of the recognized priority claims (ISK 432 billion).

### Outcomes and assessment
- The program was successfully completed, though with some delays, supported by strong ownership and a broad domestic consensus on key program goals.
- Achievements:
  - Exchange rate stabilized.
  - Much achieved in putting public finances on a sustainable path.
  - Significant progress in restructuring the banking system; private sector debt restructuring advanced.
  - Fiscal outcomes (primary balance and gross public debt) turned out better than initially projected, reflecting sizable consolidation and strong authorities’ commitment.
- Remaining and ongoing risks requiring further policy action:
  - Public debt remains large; continued consolidation is needed to secure fiscal sustainability.
  - Capital account liberalization is a key medium-term challenge: keeping controls too long could prolong distortions; too quick liberalization could deplete reserves and cause disorderly depreciation and financial instability.
  - Financial sector: still large nonperforming loans require further reduction through private sector debt restructuring.
  - Financial supervision: remaining supervisory gaps need to be addressed, consistent with the action plan being prepared by the FME.

### Key lessons from the program experience
- Four principal lessons identified:
  1. Strong ownership of the program is critical for its success.
  2. The social impact of fiscal consolidation after a severe crisis can be eased by cutting expenditures without compromising welfare benefits, introducing a more progressive tax system, and improving efficiency.
  3. A bank restructuring approach that allows creditors to take upside gains but also bear part of initial costs helps limit absorption of private sector losses by the public sector.
  4. After other policy options are exhausted, temporary capital controls can be used in crisis cases such as Iceland to prevent disorderly deleveraging and stabilize the economy.

*Prepared by the IMF interdepartmental staff team; report completed on March 9, 2012 (based on documents and data available at that time).*

### Box 1. Icesave: Background and Implications for Financing Assurances

### Box 1. Icesave: Background and Implications for Financing Assurances

### Icesave background
- Icesave was an overseas online savings account brand owned and operated by Landsbanki during 2006–08.
- It operated in the United Kingdom (from October 2006) and the Netherlands (from May 2008).
- At the time of Landsbanki’s collapse:
  - Icesave had over 300,000 customers in the United Kingdom, with deposits of over £4 billion (€5 billion).
  - In the five months it operated in the Netherlands, Icesave attracted more than 125,000 customers and €1.7 billion of deposits.
  - All Icesave deposits were about 60 percent of GDP in 2008.

### Dispute origin and negotiation timeline
- The dispute arose when Landsbanki failed and the British and Dutch governments intervened to protect local Icesave depositors because Iceland’s (private) deposit insurance fund was unable to reimburse depositors in Landsbanki’s foreign branches.
- The British and Dutch governments maintained that the Icelandic government had a legal obligation under European Economic Area (EEA) law to provide a sovereign guarantee to the deposit insurance fund and therefore sought repayment from the Icelandic government. The Icelandic authorities viewed that Iceland did not have a legal obligation under EEA law but indicated readiness to seek a negotiated solution.
- Key negotiation events:
  - First agreement: reached in June 2009 but never implemented because Iceland’s parliament did not support it and limited the government’s guarantee in a manner unacceptable to the United Kingdom and the Netherlands.
  - Second agreement: reached in October 2009 and approved by the Icelandic Parliament in December 2009; the President of Iceland did not sign the legislation and the agreement was rejected in a national referendum (March 2010).
  - Third agreement: reached in December 2010 and approved by the Icelandic Parliament in February 2011 but was not signed by the President; in April 2011 another referendum was held and the agreement was again rejected by the Icelandic public.
- The Icesave dispute was brought to EFTA Court and is being settled through legal channels.

### Implications for IMF program financing and reviews
- The Icesave dispute affected financing assurances under the program and contributed to delays in completing some program reviews.
- While an Icesave agreement was not part of program conditionality, some program reviews were delayed because of the need to reassess financing assurances from the Nordics, who linked their financing to progress on resolving the Icesave dispute.

### Litigation risks (Box 2 summary)
- Two key litigation risks to the program:
  - Depositors’ claims on Old Landsbanki (the Icesave dispute). Iceland’s obligation under the EU directive on deposit insurance was uncertain, with potential legal outcomes being: no obligation, coverage of insured deposits only, and coverage of all deposits.
  - Challenges to the Emergency Law by other creditors, which ranked (retail and wholesale) depositors ahead of unsecured creditors (including foreign banks and bondholders) in insolvency proceedings. Overturning depositor priority would have exacerbated Icesave risks because pari passu treatment of unsecured creditors and depositors would have left a smaller fraction of depositors to be covered by Old Landsbanki’s assets, increasing the burden on public finances.
- Developments mitigating litigation risks:
  - In October 2011, Iceland’s Supreme Court ruled to uphold the Emergency Law, significantly reducing litigation risks.
  - This ruling followed a similar finding by the EFTA Surveillance Authority in December 2010.
  - Remaining risks from the Icesave dispute are mitigated by the fact that Landsbanki’s estate is currently estimated to cover 100 percent of the Icesave deposits.

### Key related program context (selected points from surrounding analysis)
- Financing assurances and program sequencing:
  - Some program reviews were delayed pending reassessment of Nordic financing assurances tied to Icesave progress.
- Program risk management and fiscal implications:
  - The net fiscal costs of the banking crisis are estimated at about 20 percent of GDP (attributable in significant part to losses on loans made by the CBI in the months before the banks failed).
  - The authorities’ strategy aimed to limit absorption of private sector losses by the public sector while preserving domestic payment system functioning.
- Resolution and restructuring approach:
  - The authorities split failed banks along domestic/foreign lines rather than a classic good-bank/bad-bank approach, enabling continuity of domestic banking services while creating large nonperforming loan shares (45 percent of total loans in late 2008) in new banks.

*Source: _cr1291 - Box 1. Icesave: Background and Implications for Financing Assurances*

### 23.      The banking sector was significantly downsized, reducing risks, although the three

### _cr1291 - 23.      The banking sector was significantly downsized, reducing risks, although the three

### Banking sector downsizing and concentration
- Total assets of the three largest banks declined to about 190 per cent of GDP by end-2010, significantly lower than the close to 870 percent of GDP in 2007.
- The too-big-to-fail/too-big-to-rescue problem persists given the relative size of the three largest banks.
- Further scaling down of the new banks was judged not feasible because:
  - it would have reignited tensions about asset valuation as further breakup of the new banks would have required asset re-evaluation; and
  - it would have limited banks’ business diversification (exposure to single large business), aggravating risk concentration on banks’ assets or liabilities or both, given the presence of large borrowers and depositors.
- Policy emphasis: Because banking sector concentration seems an unavoidable “curse” of small economies, a more stringent regulatory regime and more pro-active, intensive, and comprehensive supervision were critical components of the program and will need to be intensified going forward.

### Lending activity and credit conditions
- Despite strengthening capital buffers, banks have not resumed core lending activity.
- Credit conditions have remained very tight since the crisis, reflecting both:
  - supply factors: risk aversion, deleveraging; and
  - demand factors: debt workout, weak economic outlook, unemployment.
- Recovery in lending is difficult to envisage until private sector debt restructuring has been further advanced.

### Housing Finance Fund (HFF)
- The HFF continued to enjoy a preferential regime; the state made a capital injection equivalent to 2.1 per cent of 2010 GDP to bring its capital to about 2 percent of risk-weighted assets.
- Authorities are assessing HFF’s capital needs with a view of injecting additional funds, if needed, to increase the capital of HFF to its traditional level (5 percent).
- Authorities intend further reforms of HFF based on a Ministry of Economic Affairs report on the future of the financial system and its supervision.
- In July the EFTA Surveillance Authority (ESA) recommended measures bringing the HFF in line with the state aid provisions of the EEA Agreement by end-2011.
- Notes on fiscal costs (as presented):
  - Write offs 1/: 13.0, 2.3, 3.9, 0.0, Total 19.2
  - Securities lending 2/: 6.2, 0.0, 0.0, 0.0, Total 6.2
  - Central Bank recapitalization: 6.8, 0.0, 0.0, 0.0, Total 6.8
  - Commercial bank recapitalization 3/: 0.0, 2.3, 0.0, 0.0, Total 2.3
  - Recapitalization of the House Financing Fund: 0.0, 0.0, 2.2, 0.0, Total 2.2
  - Called guarantees of the State Guarantee Fund 4/: 0.0, 0.0, 1.8, 0.0, Total 1.8
  - Public debt incurred with acquisition of assets: 11.5, 12.5, 0.0, 0.0, Total 23.9
  - Central bank recapitalization (within public debt): 11.5, 0.0, 0.0, 0.0, Total 11.5
  - Commercial bank recapitalization (within public debt): 0.0, 12.5, 0.0, 0.0, Total 12.5
  - Gross fiscal cost of bank support and restructuring: 24.4, 14.8, 3.9, 0.0, Total 43.1
  - Net fiscal cost of bank support and restructuring: 13.0, 2.3, 3.9, 0.0, Total 19.2
  - Footnotes: 1/ Capital transfers excluding the Icesave-related contingent liability of the government. 2/ Securities lending contracts that failed after the bank collapse. 3/ Retroactive interest paid to recapitalized banks to compensate for recapitalization delays. 4/ A government guaranteed bonded liability of the Agricultural Fund taken over by one of the old banks prior to the crisis; guarantee called upon failure of the bank during the crisis.

### Private sector debt restructuring
- Pre-crisis private sector debt tripled, reaching over 450 percent of GDP by end-2008:
  - household debt about 130 percent of GDP;
  - corporate debt about 340 percent of GDP.
- Private debt in Iceland at the time of the crisis was significantly higher than in past crisis countries (Nordic 1980–1990s; Asian 1997–98).
- Progress on debt restructuring was initially slow but accelerated toward the end of the program.
- Authorities favored market-based voluntary workouts and strengthening the legal framework to:
  - encourage and expedite voluntary out-of-court workouts (limited court capacity);
  - expand coverage of debt-distressed individuals;
  - reduce conflict of interest among creditors (the “hold out” problem) and asymmetry of information between debtors and creditors.
- Successive adjustments fueled expectations of more generous debt relief offers, holding back settlements; after an October 2009 accord on payment smoothing, a comprehensive package was agreed in December 2010 with a sunset clause for the restructuring offer (mid-2011).
- The pace of restructuring accelerated after December 2010, although a Supreme Court ruling (February 2012) may result in further delays.
- Program note: An Asset Management Company was considered (first review) but dismissed (second review) because it would have entailed delays, upfront additional state costs, and renewed conflicts with new bank shareholders about asset valuation.

### Strengthening prudential regulation and supervision
- Legislation was passed to rectify most regulatory failures that contributed to the banking crises; further reforms planned.
- In November 2008 an experienced bank supervisor was tasked to assess regulatory framework and supervisory practices; the Jännäri Report recommendations included:
  - strengthening discretionary powers of the FME;
  - establishing a national credit registry at the FME;
  - tightening provisions on large exposures, connected lending, and related party loans;
  - toughening fit-and-proper requirements for owners;
  - enhancing cooperation of the FME with external auditors.
- These recommendations were incorporated in an amendment (Act No.75/2010) to the Act on Financial Undertakings approved in June 2010.
- A bill pending in parliament proposed revising deposit insurance legislation in line with recent European changes; new limited deposit guarantee arrangements will eventually replace the current blanket deposit guarantee.
- Supervisory architecture:
  - Responsibility for regulating the financial sector is shared by a number of Ministries, with the FME as the unified supervisory agency.
  - This arrangement can create overlap and coordination failures; Jännäri recommended rationalizing the web of regulators.
  - The option of merging the FME and CBI was discussed; authorities decided to keep the FME independent.
  - If coordination proves ineffective, consideration could be given to tasking the CBI with supervision to integrate micro- and macro-prudential oversight, improve information sharing, and generate economies of scale given limited human resources.
- Supervisory culture and capacity:
  - A review of compliance with the Basel Committee Core Principle (BCP) found key issues remain to be implemented, delayed by institutional capacity and the need for a consistent framework or risk model.
  - The FME completed a self-assessment of BCP compliance in mid-March 2011 that was independently evaluated; addressing remaining gaps will require time and resources.

### Program conditionality on financial sector
- Financial sector conditionality was adapted to the complexities and medium-term nature of reform:
  - Early in the program half of financial sector conditions were prior actions and structural performance criteria to establish credibility.
  - Over time intensity and stringency of conditionality were reduced and structural performance criteria were eliminated to better accommodate reform complexity and avoid making the program hostage to hard timelines.

### Fiscal policy and costs of restructuring
- An impressive fiscal consolidation amounted to over 9 percent of GDP during 2009–2011, with the bulk of the adjustment achieved within 2009–2010.
- Composition of consolidation was balanced between revenues and expenditures; measures included tax increases across major taxes (including social security contributions) and expenditure cuts across budget categories while safeguarding social benefits.
- Public administration was significantly streamlined; cost-reducing reforms in education and healthcare were initiated.
- Fiscal consolidation design sought to protect vulnerable groups and place greater tax burden on higher income groups; involvement of social partners aided ownership.
- Fiscal targets were eased during the program to balance sustainability, support the economy, and preserve social objectives:
  - The authorities’ medium-term consolidation path (Nov. 2009) envisaged an overall improvement of the primary balance of 13½ percent of GDP during 2010-2012 (5½ percent of GDP in 2010, 4¼ percent of GDP in 2011, and 3½ percent of GDP in 2012).
  - In the third review (October 2010) the target for the general government primary surplus for 2011 and the medium-term target were lowered by ¾ percent of GDP; the medium term target was further lowered in the sixth review (August 2011) to support the economic recovery.
  - Public debt projected to reach 80 percent of GDP by 2016.
- Absorption of financial sector restructuring costs:
  - Actual net direct fiscal costs of financial sector restructuring turned out slightly over 20 percent of GDP, significantly smaller than initial SBA request 2008 estimates of about 40 percent of GDP.
  - Recapitalization costs for HFF and savings banks towards the end of the program were also below initial estimates.
- Fiscal framework reforms:
  - New Local Government Bill (program structural benchmark) passed by parliament in September 2011 to constrain local government finances and align them with consolidated central government plans.
  - Following IMF FAD Technical Assistance in October 2011, authorities intend to present a new Organic Budget Law to parliament by Spring 2012.

### Monetary policy and capital controls
- Monetary policy, supported by capital controls, averted a collapse of the króna and helped maintain exchange rate stability during the program.
- After the banking sector collapse, the CBI raised policy rates sharply and introduced capital controls to prevent currency collapse amid large nonresident króna holdings.
- Authorities maintained exchange rate stability throughout the program using a pragmatic combination of interest rate policy, capital controls, foreign exchange interventions, and liquidity provision.
- Restoring credibility of the CBI’s inflation targeting regime was a program objective, with exchange rate stability used as an intermediate target.

*IMF staff report content as provided in the source text.*

### 37.      The CBI actively used interest rates to achieve the monetary policy goals of

### _cr1291 - 37.      The CBI actively used interest rates to achieve the monetary policy goals of

### Monetary policy stance and interest-rate actions
- The CBI increased the policy rate by 600 basis points to 18 percent in November 2008 as a program prior action, reversing a significant easing of 350 basis points in mid-October.
- As the currency stabilized and inflation declined sharply towards its target, the CBI began a loosening cycle in early 2009.
- The CBI cut interest rates to below 5 percent by end-2010 to support the economy and facilitate restructuring of household and corporate debt.
- Despite rate cuts, inflation has proved highly persistent and inflation expectations have been loosely anchored, highlighting the need to enhance the post-program monetary policy framework.

### Monetary operations and transmission
- Monetary operations improvements increased interest rate effectiveness but further progress was needed to enhance monetary policy transmission.
- Key operational changes:
  - Strengthened liquidity provision to improve policy rate management and reduce short-term interest rate volatility.
  - Limits placed on the volume of short-term open-market operations.
  - Certificates of deposits (CD) issuance strategy adjusted: maturity lowered to 28-days (from 6 months) and auctions held weekly, with total volume geared to absorb estimated surplus liquidity.
  - Short-term market rates were brought within the CBI’s rate corridor.
  - Interest rate corridor narrowed from 500 bps to 300 bps at end-2009.
- Remaining issues:
  - Excess reserves have declined, but the CBI has not been able to anchor money market rates close to the center of the corridor.
  - The money market remains dysfunctional.

### Capital controls: stabilization, effects, and phased liberalization strategy
- Capital controls helped stabilize the currency by preventing rapid unloading of large non-resident króna holdings and avoiding a collapse of the currency that would have devastated household and firm balance sheets.
- Capital controls directed investment into government bonds, facilitating financing of the budget deficit and helping avoid a sovereign financing crisis.
- Authorities adopted a conditions-based two-stage strategy to eliminate capital controls in the medium term:
  - Stage 1: liberalize offshore króna holdings.
  - Stage 2: liberalize onshore (largely resident) króna holdings.
- Progress toward liberalization benefitted from:
  - Public finances placed on a sustainable path.
  - Strengthened banking sector.
  - Risen international reserves.
  - Regained sovereign market access.
- Factors to consider in liberalization pace (as noted):
  - Offshore króna holdings remain large and represent a considerable source of potential pressure on the currency and foreign reserves.
  - Potentially large pent up demand of residents to invest abroad.
  - The banking system, while improved, remains vulnerable to liquidity and balance sheet shocks.

### Program outcomes, quantitative results, and structural impacts
- Exchange rate: stabilized at a competitive level, avoiding further deterioration in private and public sector balance sheets.
- Fiscal consolidation: primary balance improved by 6 percent of GDP during 2009–11, placing public debt on a declining path.
- Banking sector size: now holds assets of about 200 percent of GDP (compared to around 900 percent of GDP pre-crisis).
- Household and corporate debt restructuring: advancing, which will help restore bank and private sector balance sheets.
- Program design: initial phase focused on stabilization (allowing automatic stabilizers to operate), second phase shifted to fiscal adjustment and bank restructuring.
- Risk mitigation measures:
  - Authorities limited absorption of bank restructuring costs by the public sector.
  - Monetary and exchange rate policies, combined with capital controls, mitigated the risk of large capital outflows.
  - Litigation risks reduced by Supreme Court ruling to uphold depositor priority; Icesave risks remain smaller but present.

### Remaining risks and policy priorities
- Fiscal:
  - Public debt remains large; fiscal consolidation efforts should continue to secure fiscal sustainability.
- Capital account liberalization:
  - Risk of reversing stabilization gains if liberalization is too rapid or lacks administrative controls; possible depletion of reserves and disorderly depreciation.
  - Keeping controls too long could cause distortions and resource misallocation.
- Financial sector:
  - Completion of recapitalization of the core financial system achieved, but remaining vulnerabilities persist.
  - Large NPLs need further reduction through private sector debt restructuring.
  - Financial imbalances require careful asset-liability management.
- Financial supervision:
  - Major progress made, but remaining supervisory gaps identified by the comprehensive assessment of compliance with Basel Core Principles for Effective Supervision need to be addressed in line with the action plan being prepared by the FME.

### Lessons for future Fund engagement
- Strong ownership by authorities is critical for successful completion of Fund-supported programs; authorities designed fiscal measures consistent with preserving Iceland’s social model, creating buy-in.
- Social impact mitigation: cuts backed by revenue increases and early involvement of social partners can alleviate social burdens without compromising social benefits.
- Bank restructuring approach that allows creditors to share upside gains while bearing part of initial costs helps limit public sector absorption of private sector losses.
- Capital controls can be a temporary “last resort” tool in program crisis cases when other instruments are unavailable; in Iceland’s context they were unavoidable given the large financial sector and private sector foreign exchange exposures and helped avoid disorderly deleveraging.

*Source: IMF staff report excerpt.*

### APPENDIX I. COMMENTS AND VIEWS EXPRESSED BY ICELANDIC OFFICIALS AND

### APPENDIX I. COMMENTS AND VIEWS EXPRESSED BY ICELANDIC OFFICIALS AND STAKEHOLDERS

### Overall assessment of the 2008 SBA
- Authorities and stakeholders broadly agreed with the main findings of the EPE.
- They viewed the 2008 SBA as successfully achieving its key objectives:
  - (i) stabilize the exchange rate;
  - (ii) put public finances on a path to achieving sustainability; and
  - (iii) restructure the banking, while limiting the absorption of banking crisis costs by the public sector.
- The Fund’s flexibility in program design and implementation (e.g. the design and time profile of fiscal consolidation) was considered instrumental in encouraging buy-in and ownership.
- Fund technical assistance, notably on fiscal matters, was considered particularly useful.

### Views on monetary and fiscal policy roles before and during the crisis
- Officials acknowledged that monetary policy contributed to imbalances prior to the crisis, and that monetary policy partly contributed to the carry trade in the run-up to the 2008 crisis.
- They emphasized that loose fiscal policy complicated monetary policy making and put an excessive burden on monetary policy.
- Heavy FDI and other capital inflows further complicated monetary policy conduct.
- Several officials viewed interest rates at the beginning of the SBA arrangement as set at exceptionally high levels, increasing the burden on the highly indebted private sector and stifling the recovery.
- Officials saw the need for more instruments, in particular macroprudential tools, to deal with capital flows in a small open economy such as Iceland.

### Financial sector supervision, resolution, and architecture
- Officials acknowledged home-grown supervision and regulation issues that contributed to large financial imbalances (e.g., supervision failure to allow lending to bank shareholders for equity buybacks).
- They argued that supervisory and regulatory failures at the EU level also played a role, pointing to the contradiction between:
  - the area-wide permission to operate based on home licensing and a common regulatory framework (the European passport), and
  - national supervision, a national safety net of deposit insurance and lender of last resort (LOLR), and national crisis management and resolution regimes.
- Against that background, they noted there were no legal tools at their disposal that allowed them to deal with Icesave without breaching the European passport.
- Going forward, officials emphasized:
  - the need to strengthen analytical capability of supervision,
  - providing adequate resources for FME and maintaining its independence,
  - improving information exchange among institutions under the current arrangement (streamlining supervisory arrangements may yield some economies of scale, but efficient and timely exchange of information is critical).

### Banking system restructuring and remaining priorities
- Achievements noted:
  - the banking system was downsized significantly,
  - recapitalization of the core banks was completed,
  - on- and off-site supervision was strengthened.
- Remaining actions needed:
  - speed up restructuring of nonperforming loans,
  - further strengthen balance sheets of banks, which currently operate in a protected environment given capital controls.

### Capital controls: role, risks, and recommended approach
- Broad agreement on the need to introduce capital controls at the start of the SBA and recognition of risks of quick liberalization.
- Officials acknowledged that capital controls have:
  - secured liquidity for the banks, and
  - facilitated financing of the budget.
- Concerns:
  - Keeping capital controls for long would distort resource allocation and inflict long-term costs.
- Recommended approach:
  - a balanced state-dependent approach to liberalizing capital controls, with the pace depending on whether specific conditions are fulfilled, in particular:
    - achieving macroeconomic stabilization, including implementation of a credible plan for fiscal sustainability and declining inflation;
    - a sound financial system; and
    - an adequate level of foreign exchange reserves.

### Risks moving forward and policy priorities
- Key medium-term challenges and risks identified:
  - capital control liberalization,
  - private sector debt restructuring,
  - ensuring public finances are on a sustainable path.
- Fiscal risks:
  - officials pointed to the link between fiscal risks and capital control liberalization and viewed implementation of the medium-term fiscal framework as a way of achieving sustainability.
- Growth and structural policy:
  - importance of maintaining recovery momentum over the short term,
  - boosting growth potential over the medium term by addressing underlying structural issues, including raising productivity.

### Selected quantitative highlights and program performance (as presented)
- Table 1. Iceland: Selected Economic Indicators, 2005–12 (row entries preserved as presented)
  - Real economy: Gross domestic product7.24.76.01.3-6.8-4.03.12.4
  - Total domestic demand15.59.10.0-8.6-20.3-2.33.93.7
  - Private consumption12.73.65.7-7.9-14.9-0.44.03.0
  - Public consumption3.54.04.14.6-1.7-3.4-0.6-0.4
  - Gross fixed investment34.424.4-12.2-20.0-51.6-8.113.413.8
  - Export of goods and services7.5-4.617.77.06.60.43.22.9
  - Imports of goods and services29.311.3-1.5-18.4-24.04.06.35.1
  - Output gap1/2.82.03.62.2-1.9-4.5-1.0-0.7
  - Nominal GDP (bln ISK)1,025.7   1,168.61,308.5    1,482.0    1,495.4   1,534.2   1,630.2   1,732.5
  - Unemployment rate2/2.11.31.01.68.08.17.46.3
  - Consumer price index4.06.85.012.412.05.44.04.8
  - Nominal wage index6.59.19.34.00.53.15.76.0
  - Nominal effective exchange rate3/10.2-11.82.5-40.4-34.22.9-0.1-3.6
  - Real effective exchange rate3/13.3-7.15.1-20.7-18.46.40.9-0.5
  - Terms of trade0.93.40.2-9.3-6.76.1-1.8-0.7
  - Base Money32.227.9190.7-31.51.3-19.4-20.7...
  - Deposit money bank credit (end-period)76.044.456.6-28.3-17.8-3.43.2...
  - Broad money (end-period)23.219.656.436.31.0-10.07.2...
  - CBI policy rate (period average)4/10.514.113.815.413.77.84.4...
  - General government Revenue47.148.047.744.141.141.541.741.8
  - General government Expenditure42.241.642.344.649.747.946.344.6
  - Balance4.96.35.4-0.5-8.6-6.4-4.6-2.8
  - Primary balance6.16.75.7-0.5-6.5-2.7-1.11.3
  - Current account balance-16.1-25.6-15.7-28.4-11.8-8.4-6.5-2.8
  - Trade balance-12.2-17.5-10.1-2.38.410.18.26.6
  - Financial and capital account14.043.318.1-66.9-28.252.915.3-1.4
  - Net errors and omissions2.6-11.0-1.0-19.537.3-37.7-2.80.0
  - Gross external debt6/284.5433.5605.9564.7266.5289.7250.4204.2
  - Central bank reserves (US$ billion)1.12.32.63.63.95.88.77.3

- Table 2. Iceland: Medium-Term Projections, 2009–17 (selected rows preserved as presented)
  - Real GDP-6.8-4.03.12.42.62.22.62.72.9
  - Real domestic demand-20.3-2.33.93.73.42.91.62.53.0
  - Private consumption-14.9-0.44.03.03.23.23.23.13.0
  - Gross fixed investment-51.6-8.113.413.810.76.3-2.13.64.4
  - Exports of goods and services6.60.43.22.92.92.94.03.83.6
  - Imports of goods and services-24.04.06.35.14.24.02.43.53.9
  - Output gap2/ -1.9-4.5-1.0-0.70.00.00.00.00.0
  - Unemployment rate3/8.08.17.46.36.05.04.44.04.0
  - CPI inflation12.05.44.04.83.52.52.52.52.5
  - Nominal ISK/EUR exchange rate172.0161.7161.0162.9165.9167.6168.5168.7168.7
  - Nominal GDP (bln ISK)1495.41534.21630.21732.51853.41941.72043.52149.22266.0
  - Current account-11.8-8.4-6.5-2.8-1.9-3.0-3.0-3.6-2.1
  - Underlying current account4/8.713.15.62.33.12.12.11.52.9
  - Gross external debt7/266.5289.7250.4204.2178.3167.2157.2147.3140.7
  - Central bank reserves (US$ billion)3.95.88.77.35.04.13.71.81.8
  - General government Revenue41.141.541.741.841.241.641.641.341.1
  - Expenditure49.747.946.344.643.142.341.240.640.2
  - Overall balance-8.6-6.4-4.6-2.8-1.9-0.70.40.71.0
  - Primary balance-6.5-2.7-1.11.32.33.44.34.54.5
  - Gross debt88.292.899.297.392.591.088.183.482.2
  - Net Debt55.862.864.666.464.763.160.257.153.6

- Quantitative performance criteria and indicative targets (selected numeric entries preserved as presented)
  - Floor on the change in the central government net financial balance 2/ -175 -139.5 -200 -166.7 -55 -48.4 -140 -82.9 -150 -121 -40 -11.9 -80 -55.4
  - Ceiling on the change in net domestic assets of the Central Bank of Iceland 3/ 20 34 42.6 30.3 65 16.3 40 1.1 40 -15 35 -29 13.5 -40
  - Floor on the change in net international reserves of the Central Bank of Iceland 4/ -425 -278 -475 -319 -325 -122.9 -530 68 -580 812 -592 369 -460 904
  - Ceiling on the level of contracting or guaranteeing of new medium- and long-term external debt by central government 5/ 3500 54.5 3500 486.6 2500 0 2500 1486 2500 1486 2000 0 2500 1000
  - Ceiling on the stock of central government short-term external debt 6/ 1400 0 1400 0 750 0 750 22 750 22 700 0 700 0

### Observations from figures and operational charts (as presented)
- Loan portfolio restructuring accelerated in 2011, with three largest commercial banks transferring a large share of NPLs into restructuring or legal collection.
- Monetary tightening was underway with CBI hiking rates in August and November (prior year), although forward rates did not price further rate increases in 2012.
- Excess reserves receded, reflecting more effective liquidity management and record issuance of CBI certificates of deposit in September.
- The asset side of the CBI balance sheet shows a substantial increase in gross FX reserves following completion of the IMF program and the drawing of the last tranche of the Nordic loan.
- Inflation remained above the 2.5 percent Central Bank target, with survey indicators and breakeven inflation remaining high.
- Offshore-onshore krona spread remained high, reflecting effective capital controls.
- Non-resident holdings of government securities were largely short-term, with nearly 50 percent of the stock of T-Bills held by non-residents, but a much smaller proportion of the stock of bonds held by non-residents.
- Release of offshore krona holdings may create pressure on sovereign and bank funding; banks accumulated significant liquidity buffers.

*Summary based on comments and data presented in APPENDIX I. COMMENTS AND VIEWS EXPRESSED BY ICELANDIC OFFICIALS AND STAKEHOLDERS.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1291.pdf_