Sigrún Davíðsdóttir's Icelog

Yesterday, the oral hearing in the action (Case E-16/11) brought by the EFTA Surveillance Authority, ESA, was held at the EFTA Court. ESA is requesting the EFTA Court to declare that Iceland was in breach of the EU directive on deposit-guarantee schemes (Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guarantee schemes) since it didn’t pay the Icesave (set up as a branch of Landsbanki) deposit holders in the UK and the Netherlands – and secondly, ‘that Iceland has breached the prohibition on discrimination on grounds of nationality under Article 4 EEA.’

What the Directive stipulates is that a EU/EEA state has to set up a DGS – and that’s what Iceland did: it did set up an insurance guarantee fund, TIF and thus fulfilled the Directive on exactly this point – but when needed the scheme was underfunded. Iceland then chose another way: domestic deposits were moved from the old banks in Iceland to the new banks – but no similar salvation was done in the Landsbanki Icesave branches abroad.

Consequently, Iceland asked the Dutch to pay out the Dutch ‘Icesavers’ and indicated to the Brits if they could do the same. Which is why the Dutch and the Brits think that Iceland owes them money for this – both the Directive stipulated amount, up to €20.000 on every account – and the cost accrued by the Dutch and the Brits in funding this action.

ESA’s lawyer Xavier Lewis said yesterday that it’s never happened before in the EU/EEA that deposit holders haven’t been paid. That’s the ESA view – that ‘Icesavers’ weren’t paid. That’s not entirely correct. The Dutch and the British ‘Icesavers’ were indeed paid – but not by the Icelandic TIF or by Iceland. Authorities in these countries did pay, which is why these two countries feel that Iceland still owes them both the sums stipulated by the Directive and the cost. The EFTA Court verdict will not end the Icesave dispute between Iceland and the Brits and the Dutch.

ESA isn’t taking action on behalf of the Dutch and the Brits, and it’s certainly not asking the EFTA Court to rule on fair interest rates. The ESA is only asking the EFTA Court to rule on the alleged breach of the Directive – and discrimination.

In court yesterday, Xavier Lewis referred to this Channel 4 reporting (a masterly piece by Faisal Islam) from February 2008 – on how safe deposits in Icelandic banks would be in case of failure – where David Oddsson then the Governor of the Central Bank of Iceland says the following: “These banks are so sound that nothing like that (ie banking failure) is likely to ever happen. And if something would happen you would never be talking about the whole amount of money because it’s never like that. But even so the Icelandic economy, the state being debtless this would not be too much for the state to swallow if it would like to swallow it (my emphasis).” – In the autumn of 2008 the state did indeed swallow a lot for deposit-holders in Iceland and promised to pay the Dutch and the Brits for compensating deposit-holders in these countries.

As far as I can gauge, the discrimination part is the real danger and threat to Iceland. If Iceland is seen to have discriminated between domestic and foreign deposit-holders the ruling might oblige Iceland not only to pay the foreign deposit-holders, ie the ‘Icesavers,’ up to €20.000 on every deposit but to pay the deposits in full – because that’s what was done in Iceland. Then Iceland doesn’t need to pay out ISK650bn to the ‘Icesavers’ but ISK1150bn or ca 66% of Icelandic GDP (adjusted for growth and inflation) this year.

Iceland is claiming force majeur – the Directive doesn’t cover such catastrophic events as the collapse of a whole banking system, claim the Icelanders. ESA refutes this, pointing out that the Directive does allow for “exceptional circumstances” (when deposit-holders can be paid out over a longer period). In addition, ESA points out that it can’t be the meaning of the Directive that the greater the shock the less the coverage for deposit-holders. The report for the hearing yesterday, going through the various aspects and opinions, can be found here.

The verdict is expected in December and it can’t be appealed. – It couldn’t come at a more delicate time for the eurozone.

In today’s Europe of heavily indebted eurozone countries struggling to convince the world that they can manage, think Italy and Spain, the breach of the DGS leads the thoughts to whether there actually is a state guarantee on deposits in the EU countries. Xavier Lewis and the EU lawyer, Enrico Traversa, seemed to indicate that this was the case – and yet not quite. The message was that whatever happened, depositors in the EU/EEA should rest assured that their deposits are guaranteed and safe. Safe, because the states guarantee that yes, deposit holders will be compensated, but it doesn’t mean that there is an outright automatic state guarantee.

Now, the Directive doesn’t explicitly say there is a state guarantee – so the question is, if the deposits are and should be as safe as ESA and EU claim, why this isn’t said more loud and clearly in the Directive. The answer is, no doubt, that when the Directive was in the making, everyone could agree there should be a trustworthy system – but there was no agreement as to how it should be financed so the financing was left to the individual countries. The US DGSs were an inspiration, but they don’t imply an automatic state guarantee. (A state guarantee can be a moral hazard, tempting banks to be more reckless – an intriguing topic these days).

The understanding was that the banks should finance the DGS – but some states treated their banking systems with kid gloves, didn’t want to burden them and well, in a good old tradition, raced to the bottom in order to enhance their competitive stance. How the countries go about financing their schemes still varies widely as can bee seen here in this report from 2010 by the European Commission to the EU Parliament on the Impact Assessment… on Deposit Guarantee Schemes.

The discrimination part doesn’t touch anyone but Iceland – but the interpretation of the Directive is an explosive item right now. To my understanding, there is no automatic state guarantee implied in the Directive but that doesn’t mean states don’t have some obligations. They do, ia, have the obligations to regulate and supervise their banking systems in such a way as to hinder banking failure, thus hindering that a DGS needs to be used.

Since both ESA and the EU have put some emphasis on Iceland’s shortcomings in this respect, what was said and done, the EFTA judges might focus on this, instead of referring to some sort of a state guarantee on the deposits. A breach of the Directive doesn’t necessarily incur any financial cost on Iceland. Countries are found to be in breach of some Directives all the time, do sometimes get fines but often they are just told to put their house in order.

Those of us impatient to know the outcome will do doubt ponder on different outcomes. It seems that there are already those who have toyed with a possible verdict. As in a folk tale, I found the following yesterday and thought I would share it with Icelog readers, no doubt amused and impressed by the learning and understanding shown:

Justice Nurgis’s EFTA decision

Having considered the submissions of all parties, I, Chief Justice Nurgis, rule as follows in the matter of the ESA’s complaint against Iceland concerning the Icesave deposits (Case E-16/11):

1. Iceland argues that the relevant Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guarantee schemes requires states to put in place a deposit insurance scheme but it does not require, or even imply, a state responsibility for all claims that may be made against such a scheme. Iceland further argues that it established a deposit guarantee scheme and capitalised the scheme in accordance with EU norms (roughly 1% of the insured deposit base).

2. 85% of the Icelandic financial system collapsed and the Icelandic deposit insurance scheme was obviously unable to cover those losses. The same result, Iceland argues, would be true in any country that experienced such a massive collapse of its banking sector.

3. I hold that Iceland is correct in saying that an implicit sovereign guarantee cannot be read into the Directive. It would have been childishly easy for the authors of the Directive to require such a guarantee; they did not do so because the resulting liabilities on the balance sheets of member states would have been politically and financially intolerable. Reading a matter of such enormous import between the lines of a Directive violates every norm of statutory construction.

4. Iceland’s argument breaks down, however, on the question of whether the Icelandic deposit insurance scheme was adequately capitalised. An insufficiently capitalised scheme would fail to comply with the Directive.

5. Although Iceland is correct that its scheme was capitalised in accordance with EU norms, the depth of that capitalisation must be assessed against the background of the strength of the insured institutions. It is an inverse relationship. The stronger the financial position of the insured institutions (and thus the lower the likelihood of a bank failure and call upon the deposit insurance scheme), the less the scheme needs to be capitalised in order to be in compliance with the Directive. Conversely, the weaker the financial system, the higher the required level of the capitalisation of the scheme.

 6. 85% of Iceland’s financial sector collapsed because that sector was woefully unsupervised and regulated. This much Iceland, in its own candid evaluation of the crisis, has admitted in its SIC report.

7. Iceland therefore had two honourable choices – it could either have reined in its banks and capitalised its deposit insurance scheme in accordance with the norms of other countries that similarly curb the congenitally high spirits of bankers, or it could have let its banking sector run wild but insured that when the bubble inevitably burst the deposit insurance scheme would be robustly capitalised to bear the loss. Instead, Iceland opted to abdicate its supervisory responsibilities while instituting a deposit insurance scheme capitalised at a level appropriate for a country that did engage in prudent supervision of its banking sector.

8. Accordingly, I hold there has been a breach of the Directive – not because the Directive implies a sovereign guarantee of all deposit guarantee schemes – but because Iceland’s scheme was appallingly undercapitalised in light of the bloated and unregulated nature of its financial sector.

                                         * * * *

So ordered, this 18^th day of September 2012,

Chief Justice Nurgis.

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With this ruling, no delicate feathers in the eurozone are ruffled.

As the readers can see, Chief Justice Nurgis has not ruled on the alleged breach of discrimination. The wise Chief Justice is obviously fully aware that this part of the case is a tricky one and needs further contemplation. This is the part that could possibly cost Iceland dear. A propos folk tales: there is an Icelandic version of the Faust story. Sæmundur the wise is the Icelandic Faust – but unlike the German, Sæmundur actually did beat the devil, inspiring Icelanders to fight against all odds. Remains to be seen if Sæmundur’s reckless luck will prevail at the EFTA Court.

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