Financial markets in Iceland

This paper discusses recent developments and policy issues relating to financial markets in Iceland.
Overall, the sector is thriving, both relative to history and to conditions in other countries. This bodes well
not only for those directly involved in the industry but for the country as a whole, as financial development is an important source of economic growth. Recently concerns have been expressed about the stability of the financial system; however the guarded assessment of financial supervisors and ratings agencies is that the system is broadly sound. A significant part of the credit for the vitality of the financial sector probably lies with government policy – in particular, the opening of the sector to international markets and the privatisation of the banks. Market liberalisation has been successful so far and should continue. In this respect a policy priority is to remove distortions in the market for home mortgage lending. In particular, the government guarantee for the Housing Financing Fund should be removed or neutralised; for example, by charging a fee. Iceland’s unusual reliance on indexation of loans is generally sensible for the borrowers and lenders involved and may have wider benefits. So restrictions on indexation of bank deposits and loans should be repealed. The financing of innovative start-ups is a difficult issue, where “best practice” guidelines are not obvious. Consideration should be given to use of less bureaucratic means of financing start-ups.