19 February 2013

Central Bank conducts foreign exchange transaction

The Central Bank of Iceland has concluded forward foreign exchange transaction in order to reduce foreign exchange imbalances in the banking system and ease pressure on the króna in coming months. According to the contract concluded, the Central Bank will deliver euros against payment in krónur in the amount of 6 b.kr. over the next few months. The foreign exchange reserves will be reduced by this amount over the coming months. On the other hand, this will reduce accumulation of foreign currency by institutions and market participants.

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 increased risk in the operations of the financial institutions concerned and called for higher capital charges. As the Governor of the Central Bank explained in his speech at the Bank’s Annual General Meeting in March 2010, the Bank has sought ways to ameliorate this situation so as to reduce imbalances 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 2012 report.

Towards the end of 2010, the Central Bank engaged in foreign exchange transactions in which it sold 72.5 b.kr. for foreign currency by means of forward contracts. This dramatically reduced the foreign exchange imbalances in the banking system at that time. In all, those transactions and the contracts just concluded will have increased the Bank’s foreign exchange reserves by 75.4 b.kr. at current exchange rates over the term of the contract. These transactions are linked to the current contract as they involve the Bank’s acting as an intermediary in balancing out the surpluses and deficits between parties in the system. The banks’ foreign exchange mismatches are not the main reason for the weakness of the króna in the past few months, however. More important factors are the deterioration in terms of trade and the sizeable foreign loan repayments faced by entities that have no access to foreign credit markets at present.

In view of these conditions, the Central Bank decided at the beginning of this year to suspend its programme of regular foreign currency purchases for a time and support the króna by intervening in the foreign exchange market. Although the contract just concluded will reduce the need for intervention in the near future, it is not possible to state with certainty that such intervention will be unnecessary.

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


News release no. 5/2013
19 February 2013