The Financial Sector

Introduction
Iceland has a financial system in broad line with those of other European and Western nations, and based to a large extent on EU directives. In recent years the government has been withdrawing from direct intervention in financial markets and from ownership of companies operating in them. Business credit is offered by commercial and savings banks, investment banks and securities houses. A strong non-bank sector has evolved, covering stockbroking, leasing and a wide range of other financial services. International players are established in insurance and Icelandic finance companies have associations with global funds.

Central Bank
The Central Bank of Iceland is responsible for implementing monetary policy and managing interest rates, exchange rates, etc. through market operations. Furthermore, the Central Bank administrates Iceland's foreign exchange reserves and acts both as fiscal agent for the government and the borrowing agent for the Republic of Iceland in international capital markets. Standard Central Bank functions with regard to commercial and savings banks include acting as a lender of last resort and clearing agent. The former Bank Inspection of the Central Bank and the Insurance Inspection have been merged into an independent Financial Supervision Authority, which monitors compliance with regulations covering such factors as liquidity and capital adequacy of financial institutions. Central Bank website: www.sedlabanki.is

Commercial Banks and Savings Banks
After a series of mergers in 1989-1991, Iceland now has four
commercial banks. Two were wholly state-owned but have been
partially privatised and are listed on Iceland Stock Exchange; one
is a public limited company listed on Iceland Stock Exchange, and
the fourth acts as a clearing house for the network of 26 small local
savings banks. In addition, deposit receiving facilities are operat-ed
by the Postal Giro system.
Originally Iceland's banks were sector-targeted but now all offer
a full range of financial services (including non-bank activities
through subsidiaries) to businesses and private individuals.
Housing mortgages, however, are mostly handled by a state
agency.

Bank services include all regular lending, deposit and current
account services. Interest rates and other terms vary considerably
and are determined by market forces. Companies and individuals
can hold bank accounts in Iceland denominated in major foreign
currencies.
Indexation of financial obligations, a legacy from the inflation-ary
1980s, is being phased out on shorter maturities and no longer
applies to financial obligations for a shorter period than five years.
One striking feature of banking activities in Iceland is the pre-dominance
of electronic transactions. Cheques are becoming quite
rare in day-to-day business and Iceland has the highest per capita
payment card ownership in the world, with 241,000 debit cards
and 168,000 credit cards in 1998, among a population of
275,000.
Iceland adopted the BIS standard for capital adequacy of com-mercial
and savings banks in 1992.

Financing Investments
A state-owned New Business Venture Fund has the specific aim
of funding innovations, research-driven projects and the like.
A Regional Development Fund also provides credit and grants
for projects located outside the capital area.
Iceland's commercial banks are actively engaged in corporate
lending and have extensive links with foreign banks for this pur-pose.



Mortgage Finance
The main source of mortgage finance for private housing is
through the State Housing Fund, which lends to home-buyers by
issuing them with bonds which can be transferred and traded
freely to settle housing purchases. There is a ceiling on mortgage
levels and applicants are means-tested.
Housing bonds, in fact, represent an important form of securities
trading in Iceland, accounting for 24% of total traded volume at
Iceland Stock Exchange alone in 1998.
Commercial banks are also entering the private mortgage mar-ket
and very active in financing business property development.
Although properties are more expensive in the Greater
Reykjavík Area than outside it, and although "desirable areas" do
exist, the property price range is much narrower than in more pop-ulous
countries and cities.
Most mortgages are indexed, generally against the consumer
price index.

Iceland Stock Exchange
The Iceland Stock Exchange is the official trading floor for stocks
and bonds, including treasury bonds. Since its establishment in
1985, the Exchange has grown rapidly to play a key role in the
Icelandic finance system. Trading there amounted to ISK 277 bil-lion
(USD 3.99 billion) in 1998 (47% of GDP), and increased by
47% compared to 1997. Market capitalisation of listed securities
had reached ISK 633 billion (USD 9.1 billion) in 1998, compris-ing
ISK 381 billion (USD 5.5 billion) in bonds, ISK 232 billion
(USD 3.3 billion) in equities and ISK 20 billion (USD 300 mil-lion)
in money market instruments.

There were 67 listed companies on Iceland Stock Exchange in
1998, plus a small Over-The-Counter market. Minimum require-ments
are market value of ISK 600 million (USD 8.6 million) and
300 ordinary shareholders for inclusion on the full list, and share
capital of ISK 60 million (USD 863,000) and 25 ordinary share-holders
for the "growth list." Specific requirements concerning
disclosure of information, etc. must be fulfilled before listing is
granted.

This young market's development and strengthening has been
matched by large rises in share prices. The ISE main list index
appreciated by 60% in 1996, 14% in 1997 and 10% in 1998, and
trading has become increasingly responsive to business develop-ments.
Iceland Stock Exchange website: www.vi.is

Trading on Iceland Stock Exchange is handled solely by licensed
brokers. There are twenty members in 1999, including the Central
Bank, all commercial banks and securities houses, and some sav-ings
banks. Brokerage firms handle both private and public issues
in the primary market and all types of secondary trading.
For further information on brokerage firms, see the Invest in
Iceland Agency website: www.invest.is

Institutional Investors
Pension funds, often organised along labour union lines, are a major player in the Icelandic financial system with net assets of ISK 372 billion (USD 5.35 billion) in 1997. They have played a large role in housing finance, both through their own lending and purchases of mortgage bonds, and are becoming an increasing presence in other investment areas, including equity and foreign
securities.

Some 15 closed-end mutual funds were in operation in Iceland in 1998 and eight open-end ones. Seventeen insurance companies operate as well, and are large players in the Icelandic securities
market with around half their investment portfolio in marketable shares.

Interest Rates
Interest rates are determined by market forces in Iceland. The Central Bank may influence interest rates through market opera-tions. The Bank's main objective is to secure stable prices and it is committed to a tight monetary policy in the medium term com-mensurate with that objective. Its main rate is determined at weekly Central Bank repo auctions. In recent years, interest rates in Iceland have been on average a couple of percentage points higher than those among its major trading partners.

Exchange Rate
Market forces directly influence the exchange rate of the króna in Iceland's interbank market for foreign exchange. The Central Bank is authorised to intervene, but ceased acting as a market maker in 1997. The exchange rate of the króna is measured against a basket of the currencies of its 18 main trading partners which is weighted in terms of each country's share in trade of goods and services and is revised annually. The króna is allowed to fluctuate within a ±6% band.

[ From the booklet Doing Business in Iceland, published by the Invest in Iceland Agency]