Iceland: Spectacular Turnaround from Financial Meltdown
May 2019
Iceland was among the first countries hit by the financial tsunami of the global financial crisis. With assets 10
times the size of GDP and relying on aggressive foreign borrowing, Iceland’s banking system was extraordinarily
large relative to the economy. When the Icelandic foreign exchange market and banks collapsed, the króna
threatened to spiral out of control, dealing a blow to firms and households heavily indebted with foreign currency
and inflation-indexed loans.
The IMF was called in, and within 10 days there was an agreement on a set of policy measures. The IMF-
supported program of $2.1 billion remains among the largest relative to the size of the economy—18 percent of
Iceland’s GDP, or 1,190 percent of Iceland’s quota in the IMF. The support and solidarity of other countries in the
region made Iceland an example of the ability of the IMF’s seal of approval to catalyze broad international support.
Iceland took unorthodox measures to overcome the severe crisis. The program featured policies to rebuild
confidence in the economy and garner the broadest political support:
• Capital controls with no predefined time frame were a critical part of the toolkit to restore monetary
stability. They helped stabilize the króna and prevented an increase in domestic interest rates that would
have taken a higher toll on growth and balance sheets.
• Rebuilding the collapsed banking system required splitting up the banks, which were too big to save, and
putting public money only where it was essential. A split between the failed banks’ domestic operations and
their much larger foreign operations allowed taxpayer support to focus on shielding the domestic economy,
while maximizing asset recovery.
• Phased fiscal consolidation accommodated fiscal pressure during the first year of the program and
prevented a deeper collapse in demand as government debt surged because of public support for the
financial sector. Nonetheless, there was a strong political commitment to restoring the downward path of
public debt in due course.
• Safeguarding Iceland’s social welfare system played a key role in protecting vulnerable groups and even
reducing inequality during the program.
A decade after the crisis outbreak, Iceland has already experienced eight years of robust growth averaging
close to 4 percent. The capital controls have largely been lifted, closing an important chapter in the country’s
financial crisis saga. Iceland’s current account and budget have remained in surplus for several years. Its gross
public debt has declined from 92 percent of GDP at its peak to 35 percent in 2018. Iceland now has more assets
abroad than liabilities, a high level of foreign exchange reserves, and banks that are sound and well capitalized.
IMF Lending Case Study: Iceland
Iceland: Spectacular Turnaround from Financial Meltdown
What is International Monetary Fund?
The International Monetary Fund (IMF) works to achieve sustainable growth and prosperity for all of its 191
member countries. It does so by supporting economic policies that promote financial stability and monetary
cooperation, which are essential to increase productivity, job creation, and economic well-being. The IMF is
governed by and accountable to its member countries.
Background of the Crisis
In October 2008, Iceland was significantly impacted by the global financial crisis, becoming one of the first
developed nations to seek IMF assistance. The country's banking system had expanded aggressively, with assets that
were ten (10) times the size of its GDP. This over-leverage, combined with heavy reliance on foreign borrowing,
made Iceland's financial system extraordinarily vulnerable to external shocks.
As the crisis unfolded, Iceland's three major banks collapsed, leading to a dramatic declination of the Icelandic
króna and a deep recession. The economic fallout resulted in widespread public discontent and a loss of confidence
in the financial system.
In response to the crisis, Iceland turned to the IMF for support, marking a significant moment in its economic
history. The IMF's program provided a $2.1 billion loan, which was essential for stabilizing the economy during this
turbulent period. Iceland implemented unconventional strategies to address the severe economic crisis and rebuild
confidence in the economy.
• Capital Controls
o Introduced with no predefined time frame to restore monetary stability.
o Helped stabilize the króna and prevented increases in domestic interest rates, which could have
negatively impacted growth and balance sheets.
• Banking System Restructuring
o Required splitting up the banks that were deemed too big to save.
o Focused public funds only were essential, allowing taxpayer support to shield the domestic
economy while maximizing asset recovery from failed banks’ foreign operations
• Phased Fiscal Consolidation
o Accommodated fiscal pressures during the first year of the program.
o Prevented a deeper collapse in demand as government debt surged due to public support for the
financial sector.
o Maintained a strong political commitment to restoring public debt levels over time.
• Social Welfare Protection
o Safeguarded Iceland’s social welfare system to protect vulnerable groups.
o Contributed to reducing inequality during the recovery program.
Summary
A decade after the crisis outbreak, Iceland has already experienced eight years of robust growth averaging close to 4
percent. The capital controls have largely been lifted, closing an important chapter in the country’s financial crisis
saga. Iceland’s current account and budget have remained in surplus for several years. Its gross public debt has
declined from 92 percent of GDP at its peak to 35 percent in 2018. Iceland now has more assets abroad than
liabilities, a high level of foreign exchange reserves, and banks that are sound and well capitalized.
