Tuesday, 18 September 2012

The Icesave Dispute and European Sovereign Ratings

The Icesave legal dispute is on ESA's table at the moment. The presentation of the case is in Luxembourg today. What many people don't realise is that if Iceland loses the case, the sovereign ratings of EU countries will be likely to be seriously harmed. And here's why (the very short version).

Icesave was a branch of Landsbanki in Holland and UK. When Landsbanki went bankrupt the depository fund of Iceland had to pay out the depository insurance. However, the amount of money in the Icelandic Deposit Insurance Fund was inadequate to cover the minimum EU cover: 20,887 Euros (or GBP equivalent).

The governments of the three countries got into a lengthy negotiation and the outcomes of that negotiation were the Icesave contracts. They were nicknamed "Iceslave contracts" back home. We voted on them twice and in both cases the referendum was a clear "no".

Plenty of foreigners thought this was the Icelandic people saying "no" to paying bankers' debts. That's not true. The referendums were fortunate stop-valves on our own government that wanted to make a very expensive deal with the Dutch and the British instead of going straight to court and ask: "are we, the State of Iceland, legally committed to pay out the minimum deposit insurance in case of inadequate funds in the Deposit Insurance Fund?"

In other words: is there a sovereign insurance on Deposit Insurance Funds in Europe? The EU says it's so, we don't!

So if Iceland loses the Icesave case it means that there is a formal sovereign backup on the deposit insurance funds in all the EU countries. That means that the British, Spanish, Irish, Italian, Portuguese and German governments all insure the deposits in their banks (up to 20,667 euros) no matter where in the EU they are! Depositors in Greece can park their euros in Barclays and the government of United Kingdom solemnly swears that if Barclays goes bankrupt, the UK taxpayer will pay the euros back to the Greeks. The Spanish taxpayer will reimburse the Brit who has his or her money in Santander and so on. The important difference between a subsidiary and a bank branch becomes effectively none when it comes to deposit insurance for the depositor (Kaupthing Edge was a subsidiary of Kaupthing while Icesave was a branch).

Anybody wants to make a wild guess what happens to the sovereign ratings of those countries if they are legally required to back up the deposit insurance funds? I don't think that liability is e.g. on the books of the Spanish government. Nor is it on the Dutch books.

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