Iceland In Crisis

Iceland's banking system is in very serious trouble. Here's how the crisis will affect UK savers with Icelandic banks.

Since this article was published, Alistair Darling has given a guarantee that Icesave savers will be fully compensated.

Yesterday, emergency legislation gave Iceland's financial regulator the power to force banks to merge or go into receivership.

One day on, Iceland has put Landsbanki, the country's second largest bank, into receivership.

Landsbanki owns the Icesave savings bank in the UK as well as Heritable Bank. So this news is very worrying for anyone with money in Icesave and Heritable's accounts. Icesave's UK website isn't allowing customers to withdraw money as I write.

Icelandic savers, however, are free to withdraw their money from Landsbanki's domestic branches, cash machines (ATMs) and internet operations. It is just non-domestic customers who have been cut off from their cash.

Meanwhile, Iceland's largest bank, Kaupthing, is still trading. Iceland's central bank has lent _500m (£390m) to Kaupthing so that may keep it going. What's more, Russia has lent _4 billion to Iceland's central bank to boost liquidity.

That said, I am worried about Kaupthing's future. I said last week that Kaupthing was probably strong enough to get through this. And, indeed, when you look at its liquidity and capital numbers, it looks to be ok. But in the current climate, and given the loan from the Icelandic government, I worry that I may have been too optimistic.

What does this mean for UK savers?

Let's start with Kaupthing.  In the UK, Kaupthing operates under full FSA authorisation status, granted to UK company, Kaupthing Singer  & Friedlander.

This means that if Kaupthing does fold, you can claim up to £50,000 from the Financial Services Compensation Scheme (FSCS). So unless you have more than £50,000 with Kaupthing, you should get your money back. However, it may take a few months for the FSCS to pay up. If, however, you have a fixed rate term account with Kaupthing you may have to wait longer for your cash.  The same rules apply for Heritable.

What about Icesave?

The situation is worse for Icesave. Not only is the bank in receivership, the arrangements for compensation are more complex.

As a first step, savers will have to claim from the Icelandic compensation scheme, run by the Financial Supervisory Authority - Iceland. This will pay out up to _20,887 (around £16,100). Then if you have more than £16,100 in your Icesave account, you can claim the excess up to £50,000 from the FSCS.

The worst case scenario is that the Icelandic government doesn't even have the money to pay out the £16,100. I don't think this is a likely scenario, but you can't rule anything out in the current climate.

If Iceland doesn't pay, the FSCS will only pay out the excess over £16,100. (We checked this fact with the FSCS this morning - twice.) This is a scary scenario, but my guess is that the UK government would in the end make sure that Icesave savers are fully compensated if Iceland doesn't pay up.

(By the way, again, domestic Icelandic savers are being treated differently from UK savers. Domestic Icelandic savers have a full guarantee from the Icelandic Government that 100% of their savings are safe.)

I know that many Fools have opened accounts with Kaupthing and Icesave via our site. At least one TMF staff member is in the same boat too. This is a very worrying time for all of these people.

As Bruce Jackson wrote earlier this morning: I Never Thought It Would Get This Bad.