Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh
Chapter 9: The fault lines in cross-border banking: Lessons from the Icelandic case
In the panic that gripped global financial markets after the collapse of Lehman Brothers, Icelandic banks – like so many internationally active banks around the world – were faced with a wholesale run on their foreign currency liabilities, and were therefore heading towards a default on them in the absence of a lender of last resort assistance in foreign currency. However, given the size of the balance sheets involved (10 times GDP overall, with over two-thirds in foreign currency), it was impossible for the Icelandic authorities to provide such assistance on their own. It would indeed have been catastrophic if they had made a full-scale attempt to do so. The background to these events was that the Icelandic banking system expanded very rapidly in just less than five years. Their balance sheets grew from under twice GDP at the end of 2003 to almost 10 times GDP by mid-2008. At the same time, it extended across national borders. Just before its collapse, the three major cross-border banks that constituted the bulk of the banking system had over 40 per cent of their total assets in foreign subsidiaries, 60 per cent of total lending was to non-residents, 60 per cent of income was from foreign sources, and over two-thirds of total lending and deposits were denominated in foreign currencies.
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