Financial institutions' FX imbalances reduced

Ever since Iceland’s commercial banks collapsed in October 2008, many financial institutions’ balance sheets have featured imbalances in foreign assets and liabilities far in excess of desirable limits. These imbalances increase risk in the operations of the financial institutions concerned and call for increased reserve requirements. As the Governor of the Central Bank of Iceland explained in his speech at the Bank’s Annual General Meeting in March 2010, the Central Bank has sought ways to ameliorate this situation so as to increase equilibrium in the financial system and thereby promote financial stability. Further discussion of financial institutions’ foreign exchange imbalances can be found in Volumes 1 and 2 of the Bank’s Financial Stability 2010 report.

The Central Bank initiated discussions on this matter with financial institutions, with the aim of ensuring that the banks’ foreign exchange imbalances due to net foreign-denominated assets generating income in foreign currency do not exceed 15% of their own funds. Towards the end of 2010, the Central Bank carried out foreign exchange transactions to this end. The Bank purchased foreign currency in the amount of 24.6 b.kr. (the equivalent of 160 million euros) and negotiated forward contracts amounting to 47.9 b.kr. (312 million euros). These transactions will expand the Central Bank’s foreign exchange reserves by about 72.5 b.kr. (472 million euros) during the term of the agreement.

The above transactions promote increased financial system stability and bolster the Central Bank’s non-borrowed foreign exchange reserves. In addition to its regular weekly foreign exchange purchases, which commenced in late August, the Central Bank of Iceland purchased foreign currency in the interbank market for approximately 30 b.kr. This is over and above the foreign currency that it will receive from the financial institutions through forward contracts in coming years.

Further information can be obtained from Már Guðmundsson, Governor of the Central Bank of Iceland, at tel: +354 569-9600.

No. 1/2011
3 January 2011