Capital controls and the resolution of failed Cross-Border Banks: The case of Iceland

Iceland imposed capital controls in October 2008 in order to prevent massive capital flight and a complete collapse of the exchange rate. The controls have not been lifted yet, primarily because of the risk of outflows of domestic holdings of the failed Icelandic banks. A substantial restructuring of domestic holdings of foreign creditors of the old banks is required before capital controls can be lifted. The creditors are of two types: Private investors-many of whom are distressed debt funds-and the UK and the Netherlands deposit insurance funds. A solution is likely to involve a different approach for each type of investor. In the case of private investors, a release of foreign assets combined with an exit tax on domestic assets seems the likely outcome. As for foreign deposit insurance funds, goodwill at the highest political level is required, not least in light of the recent Icesave dispute.