Working Paper: NBER ID: w24005
Authors: Sigrur Benediktsdottir; Gauti B. Eggertsson; Eggert R. Arnason
Abstract: This paper documents how the Icelandic banking system grew from 100 percent of GDP in 1998 to 9 times GDP in 2008 when it failed. We base the analysis on data from the banks that was made public when the Icelandic parliament lifted among others bank secrecy laws to investigate the run up to the financial crisis. We document how the banks were funded, and where the money went with a comprehensive analysis of their lending. We also analyze policies implemented after the crash, including emergency legislation, capital control, alleviation of balance of payment risks and preservation of the financial stability. We estimate the output costs of the crisis, which was about average relative to the 147 banking crisis documented Laeven and Valencia (2012) and the 100 banking crisis documented by Reinhart and Rogoff (2014). Our computation of the governments direct costs, reveals that the recently concluded negotiation with foreign creditors may leave the Icelandic government in net surplus as a consequence of the crisis, although there is still some uncertainty about the ultimate cost and our benchmark estimate is a cost corresponding to 5 percent of GDP. We summarize several lessons from the episode.
Keywords: Iceland; Banking Crisis; Financial Regulation; Economic Recovery
JEL Codes: E0; E32; E44; E6; E63; F31; F32; F34; F38; F51; F65; G01; G20; G21; G3; G33; H12; H6; H62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Rapid growth of Iceland's banking system (F65) | Aggressive lending practices (G21) |
| Aggressive lending practices (G21) | Systemic risk (E44) |
| Lack of regulatory oversight (G18) | Excessive risk-taking (D81) |
| Aggressive lending practices (G21) | Financial crisis (G01) |
| Insolvency of banks at the time of the crash (G21) | Overstated reported capital (E22) |
| Nature of collateralized borrowing (G21) | Erosion of banks' equity buffer (F65) |
| Financial crisis (G01) | Government's emergency laws and policies post-crisis (H12) |