Why did Iceland's banks go bankrupt?

For most of the last century, Iceland was little more than a rest stop for North Atlantic fishing fleets trawling the waters between Greenland and the Faroe Islands.

Reykjavik, where much of the island’s population of 320,000 is based, still feels like a provincial port. Taxi drivers wave to the president and there is a sense that most people are linked by blood, business or politics. But for all its sleepy air, the Icelandic capital has been transformed over the past decade. A headlong expansion into foreign markets brought the country influence out of proportion to its size and made its population one of the richest, per capita, in the world.

Now, after a week in which Iceland’s top three banks collapsed and were nationalised – putting more than €20bn ($27bn, £16bn) of depositors’ money in jeopardy across Europe – fame is turning into notoriety. As Geir Haarde, prime minister, warned this week: “The danger is real that the Icelandic economy would be sucked, along with banks, under the waves and the nation would become bankrupt.”

It is a sorry finale to what Mr Haarde’s predecessors hailed as an economic transformation that turned a poor, isolated community into a powerhouse of banks and entrepreneurs, with global investments ranging from pharmaceuticals to fund management.

The island erupted on to the world’s financial stage in the early years of this decade. Icelanders bought up swaths of eastern Europe’s telecommunications market, some of the best-known names on the UK’s high street, including House of Fraser and Hamleys, and much of the Nordic banking system.

Inevitably, observers questioned where the money had come from. Tales of strange links to Russia abounded. “It is often implied that there is something dubious or shady about the origin of Icelandic financial strength,” Ólafur Ragnar Grímsson, president, said in 2006, commenting on “far-fetched explanations” of Iceland’s sudden wealth.

Much of the mystery centred around the charismatic figure of Thor Björgólfsson, even now barely 40, Iceland’s richest man and founder of Actavis, the world’s fourth largest maker of generic drugs. He began his career by setting up a brewery in St Petersburg, which he sold to Heineken in 2002. The sale earned him $100m.

About the same time, Jón Ásgeir Jóhannesson, the youthful chief executive of Baugur, Iceland’s biggest retailer, suddenly materialised as the unknown acquirer of a big stake in Arcadia, the UK retail chain.

In reality, said Mr Grímsson, Iceland’s success was easily explained. The country had benefited from a fortuitous combination: globalisation and widespread removal of trade and financial controls, together with innovations in information technology that made its geographical isolation irrelevant.

At the foundation of Iceland’s success was aluminium smelting and a well-funded pension system based on the fisheries industry that had the money and a new appetite to invest in equities. This coincided with the deregulation and privatisation of the banking system, which allowed the island’s banks – Kaupthing, Landsbanki and Glitnir (then called Islandsbanki) – to diversify away from their traditional bases in farming and fisheries.

A class of 30-something business school alumni such as Hreidar Mar Sigurdsson, now chief executive of Kaupthing, the bank that until its nationalisation this week was Iceland’s biggest listed company, were quick to take advantage of these changes. As one banker says: “Kaupthing thought of themselves as the Goldman Sachs of the Arctic.”

Bankers and businessmen borrowed heavily abroad, invested in each others’ companies and expanded overseas. When asked where Bakkavor, the Icelandic food company, had got the money to buy Geest – a deal that turned Bakkavor into the UK’s largest ready-made food company – Mr Grímsson said: “The answer was very simple: ‘It comes from Barclays Bank’.” Much of Mr Björgólfsson’s backing came from Deutsche Bank.
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