Why Banks Should go Bust

I recently read an article where the author argues why central banks should let over-reaching banks go to bust and cites the example of how the Central Bank of Iceland handled its banking collapse in 2008.

During the financial collapse of 2008, Icelandic banks had run up debts of $86bn, an impossible sum for an economy with a GDP of $13bn in 2009. As a result, the Icelandic Central bank let its banks go bust.

The result was as expected:

Interest rates went all the way up to 18pc to try to find some kind of floor for a currency that collapsed by more than 80pc. Strict controls on bringing money into and out of the country were imposed. Iceland’s GDP, not surprisingly, took an immediate hit falling by almost 7pc in one year. Overall, four out of 10 Icelandic households were declared technically insolvent, mainly on account of the foreign currency mortgages they had taken out at the height of the boom. The International Monetary Fund had to step in with an emergency package of measures just to keep the country from sinking into the chilly depths of the North Atlantic.

Last year, its economy expanded by an impressive 7.2pc. Unemployment has dropped all the way down to 3pc, a level which means virtually everyone who wants a job has one. The krona was up by 18pc in the past year against a basket of rival currencies as global investors started to buy into its rapid recovery. Interest rates have been steadily reduced from emergency levels to 5pc, a sustainable long-term rate that rewards savers and yet makes it affordable to borrow and invest. Its debt to GDP ratio by 2015 was down to 68pc.

Do you agree with the author’s opinion that since the Icelandic Central Bank did not bail out its banks, central banks of other countries should follow its example? Personally, I disagree with the author. Iceland is a small country and has limited strategic importance in the world markets and therefore its situation is not applicable to the one in the United States during 2008.