Statement of the Central Bank of Iceland Financial Stability Committee 7 June 2023
The Icelandic financial system is on a solid footing at a time when the monetary stance has tightened. The systemically important banks’ capital and liquidity are strong. Arrears are still limited, and the banks’ operating results are good. Furthermore, recent bond issues in foreign markets have mitigated their refinancing risk, although cost of funding has increased. The Financial Stability Committee (FSN) considers the system resilient and has therefore decided to hold the countercyclical capital buffer (CCyB) rate unchanged at 2.5%.
GDP growth is strong and unemployment low in Iceland. Generous nominal wage increases have sustained purchasing power relatively well in the recent term despite high inflation. Households and businesses are faced with worsening financial conditions, however.
Steeply rising real estate prices and negative real interest rates have delivered rapid equity creation, particularly for those who financed property purchases with non-indexed loans. The adoption of borrower-based measures in the form of caps on loan-to-value and debt service-to-income ratios has reduced the risk that this rapid equity creation would be conducive to overleveraging. This can be seen in part in the household debt ratio, which has remained stable at 150% of disposable income. Households’ strong equity position affords them the resilience to withstand worsening financial conditions.
Inflation and sharply rising interest rates increase debt service burdens for those who have loans with variable nominal interest rates. Furthermore, many borrowers’ fixed-rate clauses are set to expire soon, and a rising real rate will increase the debt service burden.
The FSN urges lenders to consider this increased debt service in a timely manner so as to prevent financial distress among borrowers. Where necessary, lenders should consider lengthening loan maturities, adopting an annuity format, capping nominal interest rate payments, and offering a range of loan types that offer differing debt service. Many borrowers have ample equity and should have considerable flexibility to ensure that their debt service remains in line with the criteria provided for in the borrower-based measures set by the FSN.
It is vital to continue strengthening financial institutions’ cyber- and operational security and to bolster the resilience of payment intermediation in Iceland. The FSN is of the view that the steps taken to date towards an independent domestic retail payment intermediation solution are a positive move in this context.
The Committee will continue to apply the policy instruments at its disposal so as to preserve financial stability in Iceland, thereby enabling the financial system to mediate credit and payments and redistribute risks appropriately.
Press release no. 12/2023
7 June 2023