• ISK 1200 billion problem solved; stability ensured
• Stability conditions and stability tax on failed banks’ estates
• Currency auction for holders of offshore ISK in the autumn

At a meeting held yesterday, the Government of Iceland agreed to present before Parliament two bills of legislation sponsored by the Minister of Finance and Economic Affairs. Together, the two bills lay the foundation for a comprehensive strategy for capital account liberalisation. 

The public interest demands that the capital controls be lifted without jeopardising economic and financial stability. The objectives of the current liberalisation strategy are based on the fundamental principal that the controls must be lifted in stages without upsetting the balance in the economy and without imposing additional financial burdens on the Treasury or the Icelandic people. 

The total value of the assets underlying the problem addressed in the authorities’ strategy is about 1,200 billion Icelandic krónur. The assets fall into three categories: the ISK assets of the failed banks’ estates, which total 500 billion krónur; the estates’ foreign-denominated claims against Icelandic residents, which total 400 billion krónur; and the offshore krónur held by non-residents, which total 300 billion krónur. The authorities’ strategy prevents these assets from flowing into the foreign exchange market and thereby adversely affecting Iceland’s balance of payments. 

Stability conditions and stability tax on failed banks’ estates

The solution to the problem concerning the failed financial institutions’ estates is twofold: stability conditions are introduced and a stability tax put in place. The stability conditions, which have been approved by the Ministerial Economics Committee and the Steering Committee for capital account liberalisation, are intended to prevent adverse effects stemming from distribution of capital. If the estates complete composition agreements by the end of 2015, they can obtain authorisation to transfer funds, provided that they fulfil the stability conditions; otherwise, they will be subjected to the stability tax. The intention is to simplify the rules currently applying to the execution of composition negotiations by means of a bill of legislation amending the Act on Financial Undertakings, no. 161/2002. The bill also includes provisions requiring that a financial institution’s composition proposal (scheme of arrangements) be approved by a District Court Judge unless the Central Bank of Iceland has determined that it does not pose a threat to monetary, exchange rate, or financial stability. 

A new bill of legislation on a stability tax imposes a one-off 39% tax on the total assets of the failed commercial or savings banks in accordance with their assessed value as of 31 December 2015. The tax is intended as to address the negative effects that would derive from full distribution of capital upon the conclusion of taxable entities’ winding-up proceedings. After the tax has been paid, and upon fulfilling specified conditions, the taxable entities will be granted an exemption from the Foreign Exchange Act, no. 87/1992. Those entities that are currently in winding-up proceedings and conclude them with an approved composition agreement by 31 December 2015 will not be considered taxable entities. 

Furthermore, amendments to the Foreign Exchange Act passed by Parliament yesterday evening are intended to reinforce the premises of the Government’s capital account liberalisation measures and offset the risk created when foreign exchange transactions and capital transfers by certain parties are liberalised in stages. 

Together, these bills of legislation form a comprehensive solution to the problem that settlement of the failed financial institutions’ estates and distribution of capital to their creditors would create if no action were taken. It is estimated that Treasury revenues from the stability tax could total ISK 682 billion, after adjusting for authorised deductions. The unadjusted tax amounts to ISK 850 billion. The stability conditions solve the problem in roughly the same magnitude as the stability tax, but using a different methodology and approach. 

The capital reverting to the State as a result of the stability conditions or stability tax must not have adverse effects on the money stock; furthermore, it must not have other expansionary effects that could undermine economic stability. This capital will be used to reduce Treasury debt as the opportunity arises, as the Treasury has borne substantial expense from the collapse of the financial system. When the settlement of the failed banks’ estates and the liberalisation of capital controls are complete, major uncertainties concerning the Treasury’s debt service burden will have been eliminated, and it is assumed that interest premia and interest expense will decline markedly. 

Currency auction for holders of offshore ISK

The stock of offshore krónur creates a problem in connection with capital account liberalisation, as it consists of highly liquid foreign-owned ISK assets that would presumably have a strong impact on exchange rate stability if attempts were made to release them all at once. The offshore ISK problem is solved with currency auction and the sale of ISK- and EUR-denominated bonds with a maturity profile consistent with Iceland’s balance of payments. Owners of offshore ISK can choose from among three options: currency auction, long-term Treasury bonds, or locked non-interest-bearing accounts. The auction process ensures that all offshore ISK will be brought under control. The offshore ISK owners that bid on foreign currency in exchange for their krónur will pay a premium for doing so, thereby bearing the necessary cost of releasing them from the confines of the capital controls. 

Further information can be found on www.fjr.is/afnam.