The report of the Investigative Commission, ICR, gives a clear and detailed insight into the running of the three Icelandic banks – Kaupthing, Landsbanki og Glitnir – compareable to the insight into Lehman in Anton Valukas’ recent report. The Icelandic insight is far from flattering. Much of it should have been obvious to the actors in international markets, i.a. also the credit rating agencies, yet again raising questions about the CRAs and their methods.
As Mark Flannery points out in his article in the ICR the banks’ exponential growth and expanding operations abroad drew the attention of the international financial sector. Their growth was remarkable, ‘at least double that of the other Nordic banks. Put another way, in the same markets and under the same world financial conditions, the Icelandic banks had found a way to earn substantially more than their more experienced, overseas com- petitors. Moreover, these higher earnings were attained with a higher cost of funds, because the Icelandic banks relied more heavily on relatively expensive wholesale funding.’
Was there any reason to believe that the newcomers knew something the others didn’t know? That was often the explanation in Iceland: that the Icelandic bankers were far more clever and savvy than their competitors.
Against the apparent success stood two potential warning signs: “surprisingly low reported loan problems and a growing (but uncertain) reliance on shares to collateralize their loans.”
After the rapid expansion in 2003-05 the Icelandic banking success started to attract the attention and curiosity of foreign banks and CRAs. Their reports contained a barrage of criticism. Danske Bank’s report stung the Icelanders’ national pride and Lars Christensen, the bank’s chief economist, became the most unpopular person in Iceland.
These reports identified four problematic aspects of the Icelandic banking system: lending to related entities, questionable credit quality, funding and the expanding banking sector compared to country’s economy and the central bank’s foreign reserves.
How did the Icelandic banks and Icelandic authorities meet this criticism that led to the Icelandic mini-crisis in 2006? In just the same way as criticism was met in 2008: by changes directed toward style instead of substance, flat denial and xenophobic accusations of foreigners’ malign intents.
Kaupthing did i.a., to some degree, severe its incestuous relationship with Exista, the bank’s largest shareholder. In spite of the responses FME, the Icelandic financial services authorities, concluded, among other things, that the banks didn’t properly recognise relationships among entities they lent to. The ICR clearly outlines the banks’ rambling and inexact classification of related entities.
The Icelandic window dressing satisfied the rating companies. In February 2007 Moody’s improved the three banks’ credit rating and was, quite remarkably, widely criticised. Yet, nothing changed for the worse for the Icelandic banks until well into 2008.
The three banks did, like Lehman, direct much of its efforts at appeasing the CRAs, instead of addressing their weaknesses – and the CRAs seem to have been far too easy to fool. The CRAs have had a lot of bashing lately though possibly not enough. The Icelandic banks are just one further inglorious example of the CRAs’ failure.
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