Interbank foreign exchange market

The exchange rate of the Icelandic króna is determined in the interbank foreign exchange market, which is open from 9:15 hrs. to 16:00 hrs. on business days. In addition to the Central Bank of Iceland, three financial institutions are authorised to participate in the foreign exchange market and are designated as market makers. The foreign exchange market is governed by the Central Bank of Iceland Rules on the Foreign Exchange Market, no. 1098/2008.

The price of the Icelandic króna versus the euro is determined in the foreign exchange market, where market makers pledge to submit bid and ask quotes. The quotes are published in the Reuters information system, and only market makers have access to them. Foreign exchange market statistics.

 The Central Bank lists the official exchange rate of the Icelandic króna against foreign currencies each business day at 10:45 hrs. The exchange rate listing provides a snapshot of the position in the market at the time the entry is made. 

Main points about the interbank foreign exchange market

• Opening hours: Weekdays 9:15-16:00 hrs.

• Financial institutions are market makers in the foreign exchange market.

  • There are three market makers:

    • Arion Bank hf.

    • Íslandsbanki hf.

    • Landsbankinn hf.

  • Market makers are obliged to maintain active bid-ask quotes and update them at least every 30 seconds.

• The trading currency is the euro.

• The minimum trade amount is specified in the Rules on the Foreign Exchange Market. The trading amount is currently one million euros.

•  The Central Bank of Iceland:

  • Is a participant in the market.

  • Is not a market maker and therefore is not required to maintain active bid-ask quotes.

  • May conduct transactions with market makers at any time during the market’s hours of operation.

  • carries out a supervisory role.

• Lists the official reference exchange rate of the Icelandic króna each business day at 10:45 hrs.

Interbank market for krónur

The interbank market for krónur is an interbank market for unsecured short-term deposits and lending between credit institutions. It was established in June 1998. It operates on the basis of the Rules on Interbank Market Transactions with Icelandic Krónur, no. 805/2009, which the Bank adopted in cooperation with market agents.

The Central Bank’s role, however, is merely to organise and operate the market. It is not a market participant, as it is not authorised to grant unsecured loans. The market for krónur is also known as the REIBOR market, and interest rates in the market are called REIBOR rates. REIBOR is an abbreviation of Reykjavík interbank offered rate.

• Opening hours: Weekdays 9:15-16:00 hrs.

• Financial institutions are participants in the market.

  • There are four market participants:

    • Arion Bank hf.

    • Íslandsbanki hf.

    • Landsbankinn hf.

    • Kvika banki hf.

  • Market participants negotiate credit lines among themselves.

  • Market participants are obliged to submit binding quotes for deposit and lending rates for the following periods: overnight (ON), one week (SW), one month (1M), three months (3M), six months (6M), nine months (9M), and twelve months (1Y).

  • Market participants pledge to update their binding interest rate quotes on interbank deposit and lending rates at intervals of no less than 10 minutes.

• The maximum interest rate spread between deposits and loans in market participants’ quotes for periods of one month or longer is 100 basis points. Quotes for shorter periods are not subject to defined maximum interest rate spreads.

• The Central Bank of Iceland:

  • Is not a participant in the market.

  • Has a supervisory role and keeps track of trading in the market, which it then publishes with its statistical data.

  • Lists daily interest rates in the interbank market for krónur, with maturities ranging from overnight to 12 months. The listing takes place at 11:15 hrs. and is published on the Central Bank website shortly thereafter.

Further information on turnover in the interbank market for krónur can be found on the Bank’s website: 

Further information on the interbank market for krónur can be found in Monetary Bulletin 2002/3.

The objective of monetary policy implementation
The objective of monetary policy implementation is to support monetary policy and ensure price stability. To this end, the Central Bank sets interest rates for its transactions with financial institutions and steers the supply of liquidity that it either offers to lend or borrows in weekly market transactions. With these activities, the Bank affects short-term interest rates in the interbank market for krónur, which then affect longer-term interest rates. The Monetary Policy Committee sets the interest rates for Central Bank transactions. Monetary policy objectives.

Rules on Central Bank of Iceland Facilities for Financial Undertakings
Transactions between financial institutions and the Central Bank are subject to the Rules on Central Bank of Iceland Facilities for Financial Undertakings, no. 1200/2019.
The rules stipulate, among other things, who may be counterparties in transactions with the Central Bank, what types of transactions may take place, and what type of collateral the Bank deems eligible for such transactions. The rules are revised and updated as needed.

Counterparties in transactions with the Central Bank
Counterparties in transactions with the Central Bank are commercial banks and savings banks. Icelandic branches of foreign financial institutions may also conduct transactions with the Central Bank. Even though financial institutions are authorised to conduct transactions with the Central Bank, they do so at their own discretion.

Overnight loans and current accounts
Overnight loans are loans that counterparties to Central Bank transactions may apply for, provided that they can submit collateral deemed eligible by the Bank. Overnight loans are granted until the following business day and bear interest rates that are higher and less favourable than the rates on other types of loans. Overnight interest rates form the ceiling for overnight rates in the interbank market for krónur. A counterparty may apply for an overnight loan in order to ensure that the balance on its accounts with the Bank is positive at the close of business and to fulfil its reserve requirements.

Only deposit-taking institutions - commercial banks, savings banks, and Part A governmental institutions - are eligible to hold current accounts with the Central bank. Parties with current accounts may make deposits and withdrawals at their own discretion. The Bank pays current account interest rates on all current account balances. It is prohibited to overdraw a current account or other accounts with the Central Bank overnight. Current account interest rates form the floor for overnight rates in the interbank market for krónur.

Overnight loans and current accounts are classified as standing facilities with the Central Bank.

Market transactions and liquidity management
In order to achieve its monetary policy objective, the Central Bank of Iceland conducts market transactions with counterparties once a week, on Wednesdays. The objective of the transactions is to steer the supply of liquidity in circulation at any given time, thereby affecting interbank market interest rates. The Bank’s aim with these transactions is to keep interest rates in the interbank market for krónur as close as possible to the Bank’s key rate as defined at any given time. The Bank may conduct transactions more often than once a week if it considers it warranted.

Market conditions determine whether the Bank offers loans or term deposits to financial institutions. As a general rule, the Bank does not offer both loans and deposits at the same time. In exceptional circumstances, the Bank may deviate from this rule if conditions warrant it, such as in April 2020, when the Bank announced the temporary collateralised loan facilities.

Financial institutions’ liquidity position can change radically from day to day, due in large part to activity by the Treasury. Monthly wage payments increase the amount of krónur in circulation, and payments of withholding tax, value-added tax, and other taxes and levies to the Treasury reduce it.

Policy instruments
The Central Bank’s policy instruments are the measures or transactions that can affect the behaviour of its counterparties in connection with defined objectives. References to the Bank’s policy instruments most often include reserve requirements and transactions conducted by the Bank. Sometimes, policy instruments are not used for several years, yet they remain available if needed.

• Seven-day term deposits
  On Wednesdays, the Bank offers seven-day term deposits. The interest rate on the deposits is 0.25 percentage points higher than the current account rate. The deposits mature in seven days and cannot be withdrawn during that period. Term deposits may be used as collateral for payment system accounts and overnight loans. After the market close on Tuesdays, the Central Bank announces the amount on offer the following day. Counterparties wishing to participate in the auction submit bids, subject to a maximum of 60% of the total amount available. If submitted bids exceed the total amount on offer, the bids are reduced pro rata. Seven-day term deposits have been offered on a weekly basis since May 2014.
  

• Seven-day and three-month collateralised loans.
  For quite a while, seven-day collateralised loans were the Bank's main policy instrument. The interest rate on such loans is at the centre of the interest rate corridor. On 22 April 2020, the Bank resumed temporary issuance of collateralised loans. The Bank may grant loans for both shorter and longer periods, but all loans that it grants are collateralised, the Bank may not loan funds except against collateral in securities that it deems acceptable.  

• Reserve requirements
  The Central Bank imposes minimum reserve requirements on counterparties, as one of its monetary policy instruments. The rules in effect are the Rules on Minimum Reserve Requirements, no. 585/2018, with subsequent amendments no. 1218/2019. Reserve requirements are satisfied via financial institutions’ reserve accounts with the Central Bank. The minimum reserve requirement is a calculated as a percentage of the reserve base, which comprises deposits, plus bonds with a residual maturity of two years or less and issued by the financial institution concerned. The calculation is based on the average reserve base for the two months immediately preceding. The reserve amount is the requirement that an entity subject to reserve requirements must maintain on a daily basis over the reference period (reserve maintenance period), which is from the 21st day of the month through the 20th day of the following month. The minimum reserve requirement divided into a fixed reserve requirement and an average maintenance requirement. The fixed reserve requirement obliges entities subject to minimum reserve requirements to hold a specified amount in a separate reserve account with the Central Bank at all times. When the Central Bank imposes an average maintenance requirement, the financial institution can adjust its fulfilment of the reserve requirement to short-term changes in its payment flows. But this does not change the fact that, over the maintenance period, a specified minimum balance must be held in the reserve account with the Central Bank – a balance that the institution would otherwise have been able to allocate to other uses.
  Beginning on 21 March 2020, the minimum reserve requirement is 1% of the reserve base, and only the fixed reserve requirement is imposed. On 11 March 2020, the Bank’s Monetary Policy Committee decided to lower the average reserve maintenance requirement from 1% to 0% in order to ease the banks’ liquidity and give them greater scope to respond to changes in Iceland’s economic situation.
  In June 2018, the structure of reserve requirements was changed, and the requirement was split into two parts – a fixed non-remunerated 1% reserve requirement and a 1% interest-bearing average maintenance requirement. Until then, the entire reserve requirement had taken the form of an average interest-bearing reserve requirement. The change was made in order to reduce the cost to the Central Bank of implementing monetary policy.
  In September 2015, it was announced that minimum reserve requirements would be doubled, from 2% to 4%, effective 21 October 2015. This was done to facilitate the Central Bank’s liquidity management in the wake of large-scale foreign currency purchases by the Bank and due to the settlement of the failed banks’ estates. In December of that same year, the reserve requirement was lowered to 2.5% in order to mitigate the liquidity impact of the stability contributions made during the post-crisis settlement. Plans to lower the requirement back to 2% in connection with auctions of offshore krónur were implemented in June 2016.
  
  More information about reserve ratios
  
  Statistics on minimum reserve requirements can be found here

• Secondary market purchases of Treasury bonds.
  According to Article 20 of the Act on the Central Bank of Iceland, no. 92/2019, the Bank may purchase or sell Government-guaranteed securities or other sound securities in the secondary market so as to achieve its monetary policy objectives. To that end, the Central Bank purchases bonds in the secondary market, in accordance with the statement issued by the Monetary Policy Committee on 23 March 2020. The objective of the purchases is to ensure monetary policy transmission throughout the yield curve, so that the more accommodative monetary stance is transmitted normally to households and businesses. The transactions commenced in May 2020, and the Bank has full flexibility to adjust the amounts, frequency, and execution of the purchases in order to ensure maximum efficacy.

• Foreign exchange market transactions
  The Central Bank may conduct transactions in the interbank foreign exchange market if it wishes to do so. The Bank has traded in the market in order to expand its international reserves, and it conducts trades in order to promote the attainment of the inflation target declared in 2001. In May 2020, the Bank’s Monetary Policy Committee announced a policy of increased intervention in the foreign exchange market, and the Bank has been an active market participant since then. If the Bank buys foreign currency, the amount of krónur owned by market makers increases, and if the Bank sells currency the amount of krónur owned by market makers decreases.  As a result, frequent foreign currency purchases affect the Bank’s market activities.  The Central Bank publishes interbank foreign exchange market turnover figures on the Statistics pages of its website.

• Other policy instruments
  

  The Central Bank has other policy instruments at its disposal, chiefly to include the following:
  
  Repurchase agreements (often called repo transactions) are agreements between two parties concerning the purchase or sale of securities. Securities eligible for repo transactions are the same as those that are eligible for Central Bank loan facilities. A repo agreement has a predetermined maturity date, at which time the transaction is reversed. The Central Bank has not engaged in such transactions.
  
  Certificates of deposit (CDs) are securities that the Central Bank can issue and sell to counterparties. CDs are issued in dematerialised form by a securities depository. The terms are determined for each issue. CDs have been issued both before and after autumn 2008
  
  One-month term deposits. The structure is much the same as that for seven-day term deposits. Central Bank counterparties may submit bids to the Bank if they wish to participate in auctions of term deposits. The Bank notifies counterparties of the total amount available and the maximum bid amount. Participants submit bids specifying amount and interest rate. All participants in the auction are allocated amounts at the interest rate accepted for each auction. Bids featuring interest rates above the accepted rate are rejected. One-month term deposits were offered from June 2014 until June 2020.
  

The Central Bank and the Treasury.
It is stated in the Central Bank Act that the Bank is the commercial bank for the Treasury. The Treasury and various other Government institutions may hold current account with the Central Bank. Interest rates on Government institutions’ current accounts are the same as those on financial institutions’ current accounts with the Central Bank. The Treasury is prohibited from overdrawing its accounts with the Central Bank.

Parties are eligible for Central Bank of Iceland facilities and participants in the Bank’s real-time gross settlement (RTGS) system and netting system may provide collateral in the form of securities.

Securities deemed eligible as collateral are subject to the Rules on Central Bank of Iceland Facilities for Financial Undertakings, no. 1200/2019, with subsequent amendments.

Securities used as settlement collateral for participation in payment systems shall be governed by the Central Bank rules in effect at any time: the Rules on the Real-Time Gross Settlement System, currently no. 703/2009, with subsequent amendments, and the Rules on Activities of Netting Systems, currently no. 704/2009, with subsequent amendments.

The Central Bank reserves the right to review its decision on eligibility of specified securities in light of the conditions prevailing at any given time.

Eligible securities for facilities and payment systems (updated weekly)

In the valuation of securities as financial collateral for Central Bank facilities and participation in payment systems, a haircut shall be calculated on the reference price according to the table below:

*No market making; additional 5% haircut applied

**When using own bonds a 5% extra haircut is added

For overnight loans, the haircut is always 10% of the market value of the underlying collateral. If necessary - for example, due to market conditions - the Central Bank my calculate further deductions. The Central Bank reserves the right to reject an application for a facility if no agreement is reached on the valuation of collateral.