Friday, 10 July 2015

There are controls, and then there are controls....

Guest post by Sigrún Davídsdóttir

Now that Greece has controls on outtake from banks, capital controls, many commentators are comparing Greece to Iceland. There is little to compare regarding the nature of capital controls in these two countries. The controls are different in every respect except in the name. Iceland had, what I would call, real capital controls – Greece has control on outtake from banks. With the names changed, the difference is clear.
Iceland – capital controls
The controls in Iceland stem from the fact that with its own currency and a huge inflow of foreign funds seeking the high interest rates in Iceland in the years up to the collapse in October 2008, Iceland enjoyed – and then suffered – the consequences, as had emerging markets in Asia in the 1980s and 1990s.
Enjoyed, because these inflows kept the value of the króna, ISK, very high and the whole of the 300.000 inhabitants lived for a few years with a very high-valued króna, creating the illusion that the country was better off then it really was. After all, this was a sort of windfall, not a sustainable gain or growth in anything except these fickle inflows.
Suffered, because when uncertainty hit the flows predictably flowed out and Iceland’s foreign currency reserve suffered. As did the whole of the country, very dependent on imports, as the rate of the ISK fell rapidly.
During the boom, Icelandic regulators were unable and to some degree unwilling to rein in the insane foreign expansion of the Icelandic banks. On the whole, there was little understanding of the danger and challenge to financial stability that was gathering. It was as if the Asia crisis had never happened.
As the banks fell October 6-9 2008, these inflows amounted to ISK625bn, now $4.6bn, or 44% of GDP – these were the circumstances when the controls were put on in Iceland due to lack of foreign currency for all these foreign-owned ISK. The controls were put on November 29 2008, after Iceland had entered an IMF programme, supported by an IMF loan of $2.1bn. (Ironically, Poul Thomsen who successfully oversaw the Icelandic programme is now much maligned for overseeing the Greek IMF programme – but then, Iceland is not Greece and vice versa.)
With time, these foreign-owned ISK has dwindled, is now at 15% of GDP but another pool of foreign-owned ISK has come into being in the estates of the failed bank, amounting to ca. ISK500bn, $3.7bn, or 25% of GDP.
In early June this year, the government announced a plan to lift capital controls – it will take some years, partly depending on how well this plan will be executed (see more here, toungue-in-cheek and, more seriously, here).
Greece – bank-outtake controls
The European Central Bank, ECB, has kept Greek banks liquid over the past many months with its Emergency Liquid Assistance, ELA. With the Greek government’s decision to buy time with a referendum on the Troika programme and the ensuing uncertainty this assistance is now severely tested. The logical (and long-expected) step to stem the outflows from banks is limit funds taken out of the banks.
This means that the Greek controls are only on outtake from banks. The Greek controls, as the Cypriot, earlier, have nothing to do with the value or convertibility of the euro in Greece. The value of the Greek euro is the same as the euro in all other countries. All speculation to the contrary seems to be entirely based on either wishful thinking or misunderstanding of the controls.
However, it seems that ELA is hovering close to its limits. If correct that Greek ELA-suitable collaterals are €95bn and the ELA is already hovering around €90bn the situation, also in respect, is precarious.
How quickly to lift – depends on type of controls
The Icelandic type of capital controls is typically difficult to lift because either the country has to make an exorbitant amount of foreign currency, not likely, a write-down on the foreign-owned ISK or binding outflows over a certain time. The Icelandic plan makes use of the two latter options.
Lifting controls on outtake from banks takes less time, as shown in Cyprus, because the lifting then depends on stabilising the banks and to a certain degree the trust in the banks.
This certainly is a severe problem in Greece where the banks are only kept alive with ELA – funding coming from a source outside of Greece. This source, ECB, is clearly unwilling to play a political role; it will want to focus on its role of maintaining financial stability in the Eurozone. (I very much understand the June 26 press release from the ECB as a declaration that it will stick with the Greek banks as long as it possibly can; ECB is not only a fair-weather friend…)
Without the IMF it would have been difficult for Iceland to gather trust abroad in its crisis actions – but Greece is not only dependent on the Eurozone for trust but on the ECB for liquidity. Without ELA there are no functioning Greek banks. If the measures to stabilise the banks are to be successful then controls are only the first step.
Sigrún Davídsdóttir is an Icelandic journalist, broadcaster and writer. Her coverage of Iceland's financial crisis and subsequent recovery can be found at her Icelog, where this post first appeared. 
Together with Professor Þórólfur Matthíasson she has earlier written at A Fistful of Euros on what Icelandic lessons could be used to deal with the Greek banks. 

Image from WSJ. 


  1. Its not nessasarily so that the value of the Greek euros is the same as the euro in all other countries.
    If currency exchanges in Greece were to assist in alleviating the inconvenience of foreign transfer restrictions by offereing a Euro to Euro service they would probaby apply a discount to the Greek euros, as holding Euros in the German banking system, for example, is perceived to be of greater value than holding euros in the Greek banking system, as the recent deposit flight demonstrates.

  2. The style of your is very unique but easy to understand what you want to say in this discussion. Thanks a lot for sharing

  3. If you can't take money out of Greek banks, it is not really as good as other money. There is a real risk that like Cyprus there is a bale-in and the depositors lose half their money.

    It will be interesting to see if Greece can really lift controls or if after giving depositors such trouble they all want to take out all their money now and you get a real run on the banks.

    If you can write a check to buy something (or use a Greek credit card) but not take out cash at an ATM I can well imagine a vendor giving a different price for such a payment. If the vendor gets money in his account that he can not take out at an ATM or wire to another country it is not as good to him as cash, so a different price makes sense. Money in a Greek bank has a much higher degree of risk now.

    1. Good money is a store of value and a medium of exchange. Money in Greek banks does not get good scores on either of these metrics.