CITY FOCUS: Counting the cost of Iceland's crash

By SIMON DUKE FOR MAILONLINE and ROB DAVIES FOR THE DAILY MAIL
Updated: 18:22 EST, 13 April 2010

Even the most seasoned investors could have been forgiven for depositing their money with online bank Icesave in the angst-ridden summer of 2008.

The lender - a UK branch of Icelandic banking stalwart Landsbanki - was offering some of the most attractive rates around, even as top High Street lenders took the axe to theirs.

Just days before its closure in October 2008, Icesave's ISA carried an interest rate of 6.1pc, while its savings rates were just above 5pc, putting it near the top of 'best-buy' tables.

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Frozen over: Billions of pounds of British savings were caught up in the Icesave banking fiasco

But what investors could not have known was that behind the saver-friendly rates was a seething mass of corporate incompetence and regulatory failings in Iceland that was just months from erupting with all the ferocity of one of the island's famous geysers.

Throughout the spring of 2008, Icesave was growing its deposit book. But beneath the surface, those in the know were already fearful of an Icelandic banking meltdown.

The Bank of England was already so twitchy about the Nordic island's travails in early March 2008 that governor Mervyn King was moved to meet with Icelandic counterpart David Oddsson.

Oddsson's unusual request was that Britain perform a currency swap with Iceland, effectively providing an emergency loan. It was clear that Iceland did not have the foreign currency reserves to cover a collapse of its big three banks - Glitnir, Kaupthing and Icesave parent Landsbanki.

King's brow was sufficiently furrowed that he alerted the Financial Services Authority to the impending Icelandic meltdown.

That was in March 2008. But it was a long Indian summer before anyone thought to tell savers, or the building societies and local authorities who also banked with Icesave.

The Truth Report - issued by the Icelandic commission tasked with probing the island's banking crisis - makes clear that even as Icesave pulled in deposits from British customers, the FSA was growing panicky.

The months following King and Oddsson's tete-a-tete saw a flurry of correspondence between British and Icelandic authorities.

For its part, Britain's financial watchdog bared its teeth, but to little effect. Time and again it called on Landsbanki to shrink its deposit book, reduce mouth-watering rates and set aside more cash to provide against a collapse.

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The island bankers were not to be cowed. Right up until autumn, Landsbanki resisted the FSA's entreaties and it wasn't until Icesave was teetering on the brink that it complied. Last- ditch talks in the weeks before Icesave's demise saw Landsbanki rapidly warm to the FSA's emergency measures, particularly the idea of making Icesave a UK subsidiary, which would have placed regulatory responsibility - including the guarantee of deposits - with British authorities.

But by that time the horse had not only bolted, but was in the next field nibbling grass.

Chancellor Alistair Darling invoked anti-terror legislation to freeze Icesave's assets on October 7, 2008, leaving the cash of 200,000 British clients trapped inside the collapsed lender.

It wasn't just savers who were trapped in the crossfire - the carnage spread far and wide. Losses resulting from Icesave's death throes were cited as a factor in the merger of Britain's oldest building society Chesham with Skipton. Building societies lost an estimated £200m on Icesave alone.

Dozens of local councils were caught up in the crisis too - Kent County Council alone lost £50m on its investments with Icelandic banks. Between them, British councils had nearly £1bn invested in Iceland.

Britain is still seeking compensation from Iceland for the £2.3bn it eventually paid out to reimburse savers for their lost cash. But local authorities and building societies are yet to see a penny. All of which begs the question: Why were British consumers hung out to dry, while those in the corridors of power knew full well that catastrophe was lurking around the corner?

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For its part, the Bank has nothing to say, although privately its officials see the affair as a matter for the City watchdog.

The FSA has little to add other than that it had 'limited scope' to act because Icesave was a UK branch of Landsbanki and as such regulated from Reykjavik.

But sources familiar with the saga tell a quite different story. They say the FSA feared a public declaration of its concerns would have triggered a potentially disastrous run on Icesave, just as Britain's banking system was at its most febrile.

If that is true, it is hard to fault the FSA's logic. But logic will be little comfort to those who entrusted their money to Icesave and who may question why the needs of the banking system came before their savings.

Until the FSA, the Bank and the Government can offer a detailed account of why they played their cards so close to their chest, the question will remain unanswered.