Financial pressure remains on Iceland

The financial crisis engulfing Iceland showed no sign of easing today.

A day after Prime Minister Geir Haarde publicly criticised the lack of assistance Iceland has received from Europe, Sweden said it would lend the Swedish arm of Icelandic bank Kaupthing €435m.

The central bank said that it believed that Kaupthing was solvent, but was suffering temporary liquidity problems that could have wider repercussions.

In Britain Chancellor Alistair Darling said he would guarantee deposits of British savers with Icesave, the online arm of Landsbanki, the bank nationalised by the Icelandic government yesterday.

Britain and Sweden’s intervention underscores the effect that a full-blown collapse of Iceland’s financial system would have on the rest of Europe, given the heavy investment by Icelandic banks and companies across the continent.

In recent days, Iceland’s government has taken over the country’s second-biggest bank, fixed the exchange rate of its plummeting currency, and asked Russia for a massive loan as it tries to stop the collapse of its economy.

It has also introduced emergency laws that give the government sweeping new powers to take over companies, limit the authority of boards, and call shareholder meetings.

One of Iceland’s biggest companies, investment group Baugur, owns or has stakes in dozens of major European retailers – including enough to make it the largest private company in Britain.

Kaupthing has also invested in European retail groups, and racked up debts of more than $5.25bn in five years to help fund British deals.

The Icelandic government is also due to send a delegation to Moscow this week to negotiate the terms of a loan that it hopes with bolster its depleted foreign exchange reserves.

After watching the currency free-fall for several days, the Central Bank of Iceland stepped yesterday to fix the exchange rate of the krona at 175 – a level equal to 131 krona against the euro.

The speed of Iceland’s downfall in the week since it announced it was nationalising Glitnir bank, the country’s third largest, caught many by surprise despite warnings that it was the “canary in the coal mine” of the global credit squeeze.

With the deregulation of its financial market in the mid-1990s and subsequent stock market boom, Iceland had transformed itself from the poor cousin in Europe to one of the region’s wealthiest countries. Icelandic banks and companies made acquisitions across Europe.

The average family’s wealth soared 45% in half a decade and gross domestic product rose at around 5% a year.

But the new wealth was built on a shaky foundation of foreign debt – the country’s top four banks now hold foreign liabilities in excess of $100bn, dwarfing the country’s gross domestic product of $14bn.

Against this tumultuous backdrop, Mr Haarde vowed that ordinary Icelanders would not pay the price for this spending spree and that his country will not default on its debt.

“Iceland has never defaulted on sovereign debt and won’t,” he said.