The outlook is positive for the Icelandic economy. Economic growth has been encouraging over the last few years, even if it did fall short of expectations in 2014. Inflation has dropped sharply and is now well below the targets set by the Central Bank, which has now begun the process of cutting interest rates. Unemployment has decreased significantly in the last few years and is currently low by European standards. There is good discipline in government finances, the treasury is running a surplus and forecasts indicate that this is set to continue. The Icelandic financial system continues to gain strength, which is vital for the economy and ongoing development and economic growth. Arion Bank has enjoyed an excellent year and has consolidated its position on all key markets.
The right time to lift the capital controls
Although the capital controls were undoubtedly a necessity at the time, the fact of the matter today is that they are no longer required and indeed are arguably harmful. Lifting the controls clearly needs to be done meticulously and with the utmost caution. Any decision must also take into account the impending renegotiation of collective wage agreements. Hopefully this can be concluded satisfactorily so that stability and economic growth continue for the benefit of everyone.
Although the capital controls have virtually zero effect on new investments in Iceland, neither on Icelandic or international investors, they are clearly detrimental. The controls chiefly affect foreign investments by Icelandic residents and other investors who own ISK-denominated assets. All restrictions on the free flow of capital have a negative impact and can distort the market and price formation in this country. It is also evident that the controls impede business between Icelandic companies and international customers, suppliers and partners and in some cases may prompt major companies which contribute to the Icelandic economy to leave the country. This is why it is paramount to take this step now.
Arion Bank gets international credit rating
Arion Bank has been a pioneer among Icelandic banks in terms of accessing the international capital markets. Arion Bank was the first Icelandic bank to raise funding overseas in 2013 and at the beginning of 2014 obtained a credit rating from Standard & Poor’s. The Bank was rated BB+ and was assigned a stable outlook. In October the outlook was upgraded to positive to reflect the comfortable position of the Icelandic economy.
Although Arion Bank is fully funded and does not face significant refunding requirements over the next few years, we nevertheless aim to access the international capital markets. We demonstrated this at the beginning of 2015 when the Bank issued bonds for €300 million. The main aim of the issue was to diversify the Bank's funding and to reduce funding costs.
In recent years we have endeavoured to augment the Bank’s funding through bond issues in Iceland and internationally.
Capital controls affect the Bank‘s credit rating
The capital controls mean that the sovereign credit rating is relatively low considering the robust position of the economy and the positive government finances. This in turn means that ratings for Icelandic financial institutions are lower than expected given their financial strength and the vigorous health of the local economy. This has consequences for Icelandic companies and households as the interest terms offered to Icelandic banks on the international credit markets are consequently higher. It is therefore likely that once the controls have been lifted, Icelandic banks will be in a position to offer better terms to companies requiring debt financing in foreign currency, which in turn should materialize in better terms of business for their customers. This is yet another compelling argument for the complete abolition of the capital controls.
Interest margin in Iceland
At the beginning of this year there has been some discussion in Iceland about interest rates and the net interest margin. The net interest margin of Icelandic bank has been at or over the 3% mark in recent years. Arion Bank’s interest margin on interest bearing assets was 2.8% in 2014, falling 0.1 percentage points between years. However, it has fallen by 0.6 percentage points since 2012 and there are a number of reasons for this. One of the reasons for the high interest margin in Iceland is the small size of the country and the relatively high cost of the financial system. It's also a fact that a small economy with a relatively narrow base will always be subject to fluctuations, something which Icelanders are unfortunately all too familiar with. Fluctuations are costly because when the economy slows down, the number of defaults mount and this ends up costing the financial institutions and this cost is then reflected in the interest margin.
Our own analysis of interest margins of banks of a similar size to Arion Bank supports the findings of this survey. Banks in countries such as Denmark, Germany, the UK and the US which are similar in size to the Icelandic banks have interest margins around or just above 3%. It is therefore obvious that high interest rates in Iceland are not a result of the high interest margins of the banks but rather high Central Bank interest rates, which have been decreasing but remain above 5%, and the high real required rate of return of major Icelandic institutional inestors.
High taxes on the Bank’s funding
No place for Iceland specific rules
Financial institutions around the world are naturally subject to comprehensive regulation and official monitoring. This has been made a priority globally in recent years. We have placed great emphasis on introducing international regulations and ensuring that Icelandic financial institutions are not subject to Iceland specific rules. Separate rules make Icelandic banks less able to compete and should be avoided.
One of the best years in the Bank's history
The year 2014 was an excellent year, particularly with respect to the Bank's financial results. Return on equity in 2014 was 18.6%. Regular operations were strong and the Bank is performing well on all its key markets. In 2014 irregular items, such as the sale of the Bank's holding in HB Grandi and the listing of the company on NASDAQ Iceland had a positive impact on the annual results.
The year 2014 was an excellent year, particularly with respect to the Bank's financial results. Return on equity in 2014 was 18.6%.
One of the key tasks in rebuilding the Icelandic financial system has been to streamline operations, adapt Icelandic financial institutions to a new reality and to prepare the ground for the future. At Arion Bank we have significantly reduced the number of branches and despite having acquired several domestic financial companies and taken on more than 100 employees from those companies, the overall number of employees at the Bank has decreased.
We are currently taking several ambitious measures to further increase efficiency at the Bank. Not least among these is the implementation of a lean management system. This began in 2012 and will be completed at the beginning of 2016. Once this has been completed, we will continue the process of developing and simplifying procedures with the aim of continuously improving and further enhancing our services to our customers.
What the employees of Arion Bank have achieved over the last year, and in fact since the Bank was established, is remarkable in many ways. Arion Bank is in the front rank in Europe in terms of financial strength. At the end of 2014, the capital ratio was 26.3%, with Tier 1 capital of 21.8%, and the liquidity ratio was 174%.
The ratio of problem loans has been reduced to 4.4%. This is the result of targeted efforts over the last few years to help our customers, most of whom are in a far better position now than they were several years ago. The Bank has successfully sold the companies which it was required to take over during debt restructuring and this has maximized debt recovery. We have contributed to the rebuilding of the Icelandic stock market by focusing on helping companies go public. The listing of the seafood company HB Grandi in 2014 was an important milestone in this respect. The year 2014 was a positive one for the Icelandic stock market and the market capitalization of shares on NASDAQ Iceland increased by 30%. Arion Bank will play a key role in the listing of three companies in 2015.