This is the 8th article in the series "Popular Risk management". The aim of the series is to describe the main Risk management topics in simple, clear and concise language.  
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Written by Boris Agranovich

Was the Icesave fiasco avoidable?


This article analyses both the risk management aspects that were known to all market participants and the risk management regulatory framework which existed prior to the Icesave  approval by the DNB in May 2009. The aim of this analysis is to attempt to understand whether regulators and the DNB in particular exhausted all their means and analysed thoroughly all information available at the time of the granting of banking permission to Icesave in the Netherlands.

At the time of the implosion of Icesave the bank had more than 100,000 accounts and more than 1, 7B Euro deposited money, but according to Landsbanki’s plans before the Icesave launch it expected to take only about 400-500 M Euro by the end of  2008. It looks like the DNB could do little to prevent the explosive growth of Icesave in the first few months of its operations.

Recently a report requested by the Dutch Parliament was published by two academics,  DeMoor-Van Vugt and Du Perron from the University of Amsterdam. The report presented all events leading to the nationalisation of Landsbanki  (the mother bank of Icesave) in chronological sequence,  and analysed the actions of regulators both in the Netherlands and Iceland related to the granting of banking permission to Icesave. The report was mainly focused on the legal aspects of granting the banking license, with analysis of the European Passport regime and the home/host country model.

By granting the permit, Icesave was included in Dutch Deposit Guarantee scheme, although the home country (Iceland) was responsible for regulating the Landsbanki group. The Icelandic regulator primarily looked into the Group level reports, which were periodically submitted and showed solid liquidity buffers and withstood stringent stress tests.

The fact that the DNB granted the license provided the quality image to the bank. The authors stress that the DNB did not have the legal tools to prevent the granting of the license, but if it had been handled less favorably and more time spent analysing and asking tough questions, the whole disaster may have been prevented.

The most important recommendation of the report is that the European regulations should be substantially revised, to prevent a situation where a country bears the risk of  failure of a financial institution (via a deposit protection scheme), but has little power in regulating such institution.

The difference between Foreign Branch versus subsidiary explained

A branch of a foreign bank is obligated to follow the regulations of both the home and host countries. Because the foreign branch banks' loan limits are based on the parent bank's capital, foreign banks can provide more loans than subsidiary banks. That was probably the main reason why Icesave has been launched as a branch and not a subsidiary.

The risk management framework prior the granting of a banking license to Icesave operations in the Netherlands

Now let’s move on from the legal to the Risk management framework which existed before the time of granting the banking license to Icesave.

Liquidity regimes are nationally based according to the principle of “host” country responsibility (although in some cases, the task, though not the responsibility, of supervision of branches is delegated to the home supervisor). 

The risk assessment method used by the DNB called FIRM, which is kind of a scoring cards model. On the basis of the FIRM score the DNB sets the risk profile of an institution, which can lead either to a light or heavy supervisory regime. A branch office of a EU bank has a very small risk profile according to this model because it can request funds from the mother bank in the EU[1]

According to this method the DNB supervises on liquidity and integrity risks, which were both assessed as limited. By that time, February- May 2008, the Basel II requirements already had to be implemented and Landsbanki was informed about the requirements.

Let’s have a look now at the liquidity risk of Landsbanki at that time.

The original Basel II  accord did not include liquidity requirements and a document named “Liquidity Risk:Management and Supervisory Challenges” dated February 2008 was the main source in defining the liquidity risk framework.

In that document the following elements were highlighted: liquidity policies, stress tests, scenario analyses, contingency funding plans, setting of limits, reporting requirements and public disclosure

It is worth mentioning that one important differentiating factor across regimes is the extent to which supervisors prescribe detailed limits on the liquidity risk and insurance that banks should hold. This is in contrast to an approach that relies more on reviewing and strengthening banks’ internal risk management systems, methods and reports.

The core sentence is: the application of liquidity regimes on a local management or legal entity basis requires that each legal entity be sufficiently robust with regard to external shocks. This may require a pool of liquid assets to be held locally, or for each entity to have independent access to contingent liquidity lines.

This pool has been requested by the DNB from Landsbanki but only just before the Landsbanki collapsed (September 2008).

Diversity in liquidity regimes

Liquidity regimes are affected by policy choices made by national authorities relating to the desired resilience of banks to liquidity stress. Factors include those nationally determined such as insolvency regimes, deposit insurance guarantees, and central bank credit and collateral policies, including intraday, standing facility, or emergency liquidity assistance arrangements, as well as the structure of the banking sector itself.

Communication between regulators

In the European Directive on Financial Stability a home country is obliged to contact the host country in question in case of known deficiencies. Strangely enough, on request of the DNB to provide more explanation about the explosive growth of Icelandic banks and liquidity problems , the FME (Icelandic supervisor) replied in August 2008 as following: “.. Landsbanki’s business is healthy, capital levels are strong and it performs well in various stress-tests that the FME applies. [2] .

Role of the supervisors in analyzing the market trends

In the Basel document regulating liquidity management it was clearly stated that to protect local entities supervisors have a duty to help ensure the resilience of entities within their jurisdiction to protect local depositors.[3]

In the later document issued in September 2008 and named “Principles for Sound

Liquidity Risk Management and Supervision” there is more clear description of the role of supervisors with an emphasis on the comprehensive assessment of a bank’s overall liquidity risk management framework by the monitoring of a combination of internal reports, prudential reports and market information. The market information was a missing link in the analysis of Landsbanki. The main European and Dutch banks had already withdrawn from Iceland by the end of 2007 as more reports came in indicating that the Icelandic economy and banks grew very fast and the bubble might burst very soon. The Swap rate of Icelandic banks and specifically Landsbanki were very high in the interbank market. This means that counterparties have less trust with these banks than with other banks. It worth mentioning that the Swap rate of Landsbanki was very high, (see a graph in the attachment).

So consequently the market knew that something was wrong with the Icelandic banks, but supervisors it seems were unaware or seemingly ignored the market behaviour.   

Challenges in Liquidity Risk Management and Key Risk indicators

In certain circumstances, firms may also face challenges in transferring funds and securities across borders and currencies, especially on a same-day basis. For example, institutions operating centralised liquidity management may be dependent on foreign exchange (FX) swap markets.

For example, if the liquidity reserve of a bank in for instance NL is transferred within a cross-border group to Iceland where the local entity faces a liquidity shock but the transfer fails to resolve the problem within the group, the local entity in NL is likely to come under severe pressure and will have no liquidity buffer to prevent failure. In that event, depositors in NL are in a potentially worse position than before the transfer. If however  the transfer succeeds in stemming the problem, and there is no reputational contagion, then depositors in Iceland would be better off and those in NL no worse off.
A bank also should design a set of key risk indicators or KRI’s to identify the emergence of increased risk or vulnerabilities in its liquidity risk position or potential funding needs. Such early warning indicators should identify any negative trend and cause an assessment and potential response by management in order to mitigate the bank’s exposure to the emerging risk.

Early warning indicators can be qualitative or quantitative in nature and may include but are not limited to:

• rapid asset growth, especially when funded with potentially volatile liabilities

• growing concentrations in assets or liabilities

• increases in currency mismatches

• a decrease of weighted average maturity of liabilities

• repeated incidents of positions approaching or breaching internal or regulatory limits

• negative trends or heightened risk associated with a particular product line, such as  rising delinquencies

• significant deterioration in the bank’s earnings, asset quality, and overall financial condition

• negative publicity

• a credit rating downgrade

• stock price declines or rising debt costs

• widening debt or credit-default-swap spreads

• rising wholesale or retail funding costs

• counterparties that begin requesting or request additional collateral for credit exposures or that resist entering into new transactions

• correspondent banks that eliminate or decrease their credit lines

• increasing retail deposit outflows increasing redemptions of CDs before maturity

• difficulty accessing longer-term funding

• difficulty placing short-term liabilities (eg commercial paper).

In my opinion many of these KRI’s were in red during the approval period in first half of 2008.

On December 17, 2009, the Basel Committee on Banking Supervision (BCBS) issued two consultative documents intended to apply lessons of the financial crisis to strengthen bank capital and liquidity frameworks while harmonising cross-border supervisory approaches. The central purpose for these revisions is to emphasise the holding of higher-quality capital and widen the pool of risks it is to support.


It is certain that that the Icelandic authorities bear responsibility for the Icesave collapse, but also so do the Dutch and UK authorities for allowing Icesave to operate in their markets without adequate regulation and supervision of its operations or an appreciation of the consequences of a collapse (notwithstanding the European passport rules that allowed Icesave to operate in those markets).

The actual CDS spreads, the Basel II working rules on risk management that prescribes the DNB to do an integrated risk assessment, including Landsbanki and the FX exchange risk, the problems with the loans of Icelandic banks with the Luxemburg Central Bank, the different ‘warning’ reports on Icelandic banking by market participants and the lack of reserves in the Icelandic Central Bank were all reasons enough to at least take more than a formal procedural approach during granting the banking license to Icesave.

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Written by Boris Agranovich

[1] DNB vision on regulation 2006-2010 (

[2] De bevoegdhededn van DNB inzake Icesave

[3] Liquidity Risk: Management and Supervisory Challenges. BCBS February 2008, page 8