Bank deposit dispute may delay Iceland talks

Posted by Michael Berendt on 27/02/10

Ironic that the European Commission’s positive report on Iceland’s application to join the EU, produced in just six months, should have coincided with the breakdown of talks over the €3.9 billion which the Netherlands and the UK are demanding from Iceland for the collapse of the Icesave bank. It is widely predicted that Icelanders will vote against the terms of repayment in the March 6 referendum, inevitably requiring new negotiations.

A Council decision to launch accession talks will have to wait until this dispute has been resolved. Meanwhile the $10 billion IMF loan to Iceland is suspended and Iceland’s government, which had accepted the terms of the payment before their president intervened, may be in a precarious position.

Talks to agree revised terms apparently collapsed on Thursday February 25. Enlargement Commissioner Stefan Füle was careful to distance the Commission from the dispute, treating it as a bilateral issue, but the crisis of October 2008 did raise some fundamental issues about the way in which the EU banking passport and deposit guarantee schemes ought to work together, so Brussels is to some degree implicated.

It seems that Iceland’s regulators were responsible under the principle of home country control for overseeing Icesave’s internet campaign to take retail  deposits in the UK and the Netherlands. Some 400,000 savers were tempted by the high interest rates on offer (to say nothing of the local authorities and other depositors who hadn’t learnt that when something looks too good to be true, it probably is!).

However, nobody in Iceland took account of where the liability for deposit guarantees would lie in the event of a bank collapse. That might sound shocking, except that almost no other EEA country had thought about it either, and no provision is made under European legislation as to how the deposit guarantees should be funded.

In the end it was everyone’s taxpayers who had to pay – not easy in a country with a population of 320,000 people and liabilities of nearly €4 billion, amounting to €12,500 per person or equivalent to one-third of national output.

For the British and Dutch a settlement of the deposit guarantee issue is a precondition of enlargement talks. They are implying that this is sovereign debt, where a failure to pay amounts to sovereign default, which seems a bit steep given the abject failure of any European regulators to anticipate what was happening in the markets or to co-operate in identifying risks. It looks like a penalty for bad behaviour of which everyone else was guilty too. And it is worth remembering that Iceland accepts the principle of repayment.

As to EU membership, the Commission’s report emphasises the nature of Iceland’s democracy, its open economy, and close European co-operation over 40 years, which make it the ideal candidate. Its participation in the European Economic Area (EEA) since 1994 means that much of EU law already applies in Iceland. It has been a Schengen member since 2001.

The Commission has some concern over aspects of the judicial system and the close links between business and politics, but it is fisheries policy which will obviously cause the biggest difficulties in negotiation (once the bank deposit repayment has been sorted out). At least the benighted EU fisheries policy is now in a state of flux, which may provide some opening for an agreement. It was interesting to see that the European Parliament, which now has a say for fisheries under the Lisbon Treaty, has just endorsed the need for change.

Iceland’s membership could be the catalyst Europe needs to save its dwindling fish stocks and create a sustainable fishing industry.  There may be some useful lessons for banking policy too!

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