A good regulatory framework and robust supervision, efficient banking operations and sound ownership of financial undertakings are the three main pillars which need to shape the future vision for the Icelandic financial system. This is the conclusion of the working group appointed in February to prepare a White Paper on the financial system. The group has now completed its work and submitted its report to the Minister of Finance and Economic Affairs.
The purpose of appointing the working group was to create a solid basis for subsequent discussion, setting a strategy and taking decisions on issues relating to the financial system, its future structure and development. The Minister of Finance and Economic Affairs will request open debate in the Althingi on the contents of the report at the beginning of the spring session, in addition to its discussion by the Economic Affairs and Trade Committee. The White Paper will also be published on the government's consultation portal and readers invited to submit comments on its contents. The government will follow up with proposals for changes to the financial system.
The White Paper deals with the transformation which the regulatory framework of the global financial system has undergone since the global banking crisis. This is reflected, among other things, in international rules that have been introduced in a similar form in Iceland as in most developed countries of the world. Risk in the Icelandic banking system has been significantly reduced, banks are more capable of dealing with shocks, supervision is stronger and a contingency plan has been prepared. The working group emphasises that a decision should be taken on drawing a line of defence for investment banking activities by commercial banks and that a centralised debt database be established, which can be utilised by the government and financial undertakings to improve information on household and corporate indebtedness. It is also pointed out that active competitive competition and strong customer discipline are key prerequisites for cost-efficiency benefits to be passed on to consumers and small businesses. These factors are important in order to restore confidence in the Icelandic financial system.
Focus on lower interest rates and better terms
The White Paper points out that access to financial services on fair and affordable terms is an issue of major concern for households and corporates. In a survey conducted for the working group, lower interest rates and better terms were the factors mentioned most often by respondents as likely to increase confidence in the banking system. In this context the group emphasises the importance of distinguishing between interest rate level and interest margin. High lending rates reflect to some extent the high policy rate which is part of the banks' external environment, while the efficiency of banking operations is reflected in their interest margin and service charges.
The report states that the small market size, high taxes and relatively high capital requirements result in what is referred to as the "Iceland premium”. It is difficult to enlarge this market without increased risk or changing the currency arrangements, and capital requirements are determined by the assessment of various risks. This makes it difficult to reduce these costs in the short term. On the other hand, operating costs could be reduced through increased collaboration in the operation of financial infrastructure and the reduction of specific taxes. Such actions are in the hands of the government and the banks themselves. Active competition and consumer protection, however, increase the likelihood that improved efficiency will benefit consumers.
Arguments for reducing ownership
The White Paper looks at changes to the state’s ownership of financial institutions which will have a significant impact on the future of the financial system. It states that the existing strong regulatory framework and supervision are aimed at ensuring sound ownership by setting requirements for owners of qualifying holdings and limiting the impact of owners.
It points out that there are arguments for reducing the state's extensive ownership of financial undertakings in order to reduce the risk, opportunity cost and negative impact on competition. In anticipation of the sale of the banks, priority should be given to reducing specific taxes and setting a statutory line of defence. It is also important that the government consider its overall strategy for long-term ownership, as diversified ownership tends to increase acceptance and reduce risk.
The Chairman of the working group is Lárus Blöndal, Supreme Court attorney and Chairman of the Board of Icelandic State Financial Investments. Other members are Guðrún Ögmundsdóttir, Head of Liquidity and Financial Undertakings in the Financial Stability Department at the Central Bank of Iceland; Guðjón Rúnarsson, attorney and former managing director of the Icelandic Financial Services Association; and Kristrún Tinna Gunnarsdóttir, economist at Oliver Wyman in Sweden. Sylvía K. Ólafsdóttir, department head at Icelandair, was also appointed a member of the group and was active in its work until this past summer.
Main Emphases and Conclusions