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Financial Stability Council

The Financial Stability Council is a formal co-operation forum of public authorities for financial stability. The Council serves as venue for consultation, exchange of information and policy formulation with the aim to strengthen and preserve financial stability in the public interest, limit the build-up of systemic risk and co-ordinate the preparedness of public authorities for financial crises.

The principal tasks of the Financial Stability Council are the following:

  • to formulate official policy on financial stability;
  • to monitor economic imbalances, financial system risks, undesirable incentives and other conditions that are likely to jeopardise financial stability;
  • to assess the effectiveness of macroprudential policy tools

Macroprudential tools

Macroprudential supervision focuses on the financial system as a whole, supervising the interplay between the participants in the system and the relationship between the financial system and the overall economy. Increased emphasis has been put on macroprudential surveillance worldwide as the supervisors’ viewpoint in the antecedent to the global financial crisis is generally considered to have been too narrow. A few macroprudential policy tools have been adopted into Icelandic law with the aim to strengthen financial stability. These are:

  • capital buffers
  • limits on mortgages to consumers
  • limits on lending in foreign currency

Capital buffers

Capital buffers are the subject of Articles 86 a. – e. in Act no. 161/2002, on Financial Undertakings. The Central Bank of Iceland issues rules on the countercyclical capital buffer, the systemic risk buffer and the buffer for systemically important institutions.

The table shows the capital buffers in effect in Iceland as of 18 March 2020. The capital buffers are in addition to general capital adequacy requirements.

risk buffer
Buffer due
to systemic importance
conservation buffer*
capital buffer required
Arion Bank hf.
Íslandsbanki hf.
Landsbankinn hf.
Kvika Bank hf. and savings banks**
Credit institutions***

    * A capital conservation buffer is applied pursuant to Art. 86 e of Act No. 161/2002; the Central Bank does not issue rules on this buffer.
    ** Savings banks Sparisjóður Austurlands, Höfðhverfinga, Strandamanna and Suður-Þingeyinga.
    *** Borgun hf., the Institute of Regional Development, Municipal Credit ohf. and Lykill fjármögnun hf.

Limits on lending

Act no. 118/2016, on mortgage lending to consumers, has a provision to limit the loan to value (LTV) ratio of new loans and the loan amount in relation to a borrower’s income (DTI/DSTI). Only the limit on LTV is currently active and the general maximum LTV is 85%, while first-time home buyers may have up to 90% LTV. Rules to this regard were issued in July 2017 with the aim to preserve financial stability and increase the resilience of both lenders and borrowers to imbalances in the housing market.

According to the Act on Foreign Exchange, in order to preserve financial stability, the Central bank can limit lending in foreign currency by credit institutions to unhedged borrowers. Such rules could restrict the maturity of FX loans to unhedged borrowers, specify appropriate collateral for such loans or set a maximum ratio of such loans in a credit institution’s loan portfolio. The ratio can be decided as an overall ratio or a specific ratio for certain categories of unhedged borrowers. The Central Bank can also set rules on reporting of lending in foreign currency to unhedged borrowers. Rules to this effect have not been issued at this time.

Other policy instruments that support financial stability

Rules on credit institutions’ liquidity ratio aim to reduce liquidity risk by requiring credit institutions to hold liquid assets to meet their liabilities over a specific period. Credit institutions must have available liquid assets to meet liabilities not only on their due date but also possible outflows due to deposit withdrawals, limited access to financing, increase in demand for collateral or other instances that would require outflows under stress over a defined 30 day period. There is a minimum ratio in ISK (50%), minimum ratio in FX (100%) and a minimum combined ratio (ISK+FX, 100%).

Rules on funding ratios in foreign currencies aim to limit maturity mismatches between commercial banks’ foreign denominated assets and liabilities and limit the extent to which commercial banks rely on unstable short-term funding to finance long-term assets denominated in foreign currencies. The minimum funding ratio in foreign currency is 1, taking into account the institution’s foreign balance. The rules require institutions to calculate the ratio for ISK and for total exposure (FX+ISK) without setting a minimum ratio for these.

The special reserve requirement for new foreign currency inflows was put in place in June 2016 with the aim to dampen and influence the composition of inflows of foreign currency to domestic debt markets and high-yield deposits as well as to strengthen the transmission of monetary policy. The special reserve requirement is currently at 0%, rendering the requirement effectively inactive.

Systemically important financial institutions and infrastructure

Systemically important financial institutions and infrastructure are those whose financial or operational difficulties can have a significant negative impact on the stability of the financial system and the economy, usually due to their size or the nature of their business. Consequently, the public safety net is usually stronger and direct and indirect guarantees more common for these types of institutions and infrastructure. This, in turn, can lead to these institutions or infrastructures taking more risk than would be considered beneficial for the financial system as a whole. A robust regulatory framework leans against this moral hazard and supports an effective supervision of these entities. Arion banki hf., Íslandsbanki hf. and Landsbankinn hf. are considered systemically important supervised entities in Iceland.

Furthermore, the Real-time Gross Settlement system of the Central Bank of Iceland, the payment mediation system of Greiðsluveitan ehf. and the securities settlement system of NASDAQ Securities Depository hf. are considered systemically important infrastructure.

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