GLITNIR’S BANKRUPTCY

1GLITNIR’S BANKRUPTCY

A Study of the Causes of Glitnir’s Bankruptcy and the Necessary

Steps taken to Overcome the Situation

Prepared By:

Nada Bedir S00012865

Fatma Mohammad S00007391

Aisha Al-Omran S00005692


Introduction

The global financial crisis of 2007 was mainly triggered by shortage in liquidity. The

liquidity problem was caused by high inflation, which led to a credit crisis. This credit crisis

was not only because some lenders could not pay their loans, but also was because many

banks were making risky decisions. For example, some banks give too much risky loans, or

they giving more loans than excess reserves. Another reason for the crisis is some banks

focused more on the short-term high profit by investing in high risk investments, rather than

planning efficiently for the future. One of the banks that made risky decisions by investing in

high risk investments, and had to face a financial crisis is Glitnir bank (known today as

Islandsbanki).

Glitnir bank is one of the largest Icelandic banks, holding 88% shares of the Icelandic

banking market. The bank has in recent years expanded its services to reach abroad markets

such as UK, US, Indian, Chinese, and Scandinavian markets (E-business-watch). According

to E-business-watch, Glitnir bank's main source of income is corporate and retail banking,

along with all variety of financial products.

In 2006, Glitnir banks financial operations started to take on more risky investments

which led to the fall down of the bank in 2007 (Þórisson, 2006). The risky investments

included concentrating in investing in the unstable sectors such as the seafood and sustainable

energy. It also includes risky securities which led to default risk.

Along with the bank's risky investments, the bank's low capital ratio, which was

5.19%, played a major role in its fall. In addition, it must be noted that Glitnir bank was built

on too much debt. All of these factors contributed to the bank's fall.

However, the Icelandic government decided to step in to save the economy by buying

75% of the bank's stock (islandsbanki, 2008). Nevertheless, the government announced that

this control will not last for long; the bank's creditors now acquire 95% of the capital and the

state only owns 5% of the stake as a way to reschedule the bank's debt (islandsbanki, 2008).

The name of the bank has also changed to "IslandsBanki" as a way to restore

consumers' confidence. Glitnir’s financial problems were due to the risky decisions taken by

its management; this is why the bank will be an ideal case study for a risk management paper.

This research paper is going to analyze Glitnir’s financial problem. The paper is going

to explore the inefficient use of assets and the extensive reliability on debt which led to a

major deterioration in the Glitnir's capital. Furthermore, it will explore the government's

role in saving the bank. Moreover, it will examine the steps that the new management team

took in order to build a strong new bank “Islandsbanki”.


Methodology

To analyze the bank’s financial problem, the paper is going to examine three points

that led to bankruptcy which are: engaging in risky investments, maintaining a low capital

ratio, and relaying on too much debt. In order to examine the situation explicitly, different

sets of data were used to support these three major causes. The data includes: the balance

sheets of the years of 2008 and 2009 and Glitnir’s Hedge Fund 2007 annual report (Refer to

Appendix). In addition, some ratios were calculated to contribute to the analysis section of

the paper. These ratios include: ROA, loan to assets ratio, and cash ratio. Moreover, the GAP

analysis was conducted to measure interest sensitivity. After investigating these three causes,

the paper will demonstrate the steps taken in order for the bank to overcome the insolvency.

Data

Return on Assets

The return on assets ratio indicates how beneficial the bank management is compared

to its total assets. It is the ability of generating profit using all the resources of the firm

(Beranek). We have calculated the ROA using formula (1):

Return on Assets = (Net Income / Total Assets) * 100 (1)

Figure 1

As it is shown in (Figure1) Glitnir’s return on assets in 2006 were close to 2%.

However, in 2007 the return on assets dropped below 1%. This high drop could be an

indicator of the crisis. It shows that there is something threatening the economy.


Loan to Assets Ratio

The loan to assets ratio measures the loans to assets. The higher the percentage, the

lower liquidity the bank has. So that, it might also indicates the risk status if we devote more

assets to loans (Beranek, n.d.). It is calculated through formula (2).

Loan to Assets Ratio = (Net Loans / Total assets) *100 (2)

Figure 2

There is a high percentage of Glitnir’s assets that dedicated to loans. It might indicate

the amount of borrowers in the economy and the investment rate within the economy. This

could be seen as how Icelanders are sure of their economy.

Cash Ratio

Cash ratio is the amount of cash the bank keeps liquid compared to its total assets.

The bank needs to hold more cash available to use in times of emergency. It is also could be

calculated by adding the cash and the securities; however, in Glitnir’s case as an Icelandic

bank, we will calculate cash only, because in such a small country that has its own currency

securities will be hard to sell in times of crisis (Beranek, n.d.). The Cash Ratio formula is as

following: Cash Ratio = (Cash / Total Assets) * 100 (3)

Figure 3


As it is shown in (Figure 3) Glitnir has very low rate of liquidity that does not exceed

2% out of its total assets. To economists it is very clear that there is something around the

corner.

Gap Analysis

Gap analysis measures the interest sensitivity. It compares the sensitive assets to the

sensitive liabilities. It is a tool that helps comparing between the recent status and the future

position, or where do they want to be? This tool could help evaluating the interest rate risk

and liquidity risk as well. Conservatives might like to shrink or minimize the gap between

rate sensitive assts and rate sensitive liabilities to avoid risks. However, many risk takers

would take the advantage from the changes in interest rates and maximize the gap after

predicting a higher interest rate in the future. When interest rate goes up it will help the bank

making a good business, on the other hand, when the gap is in the negative side the opposite

is true (Beranek, n.d.). The Gap analysis could be measures using the following formula:

Gap = RSA - RSL (4)

Figure 4

In Figure 4, the gap analysis is divided by the equity capital; this is to make sure that

even in the worst cases the bank could cover the short term losses by the equity. The bank is

in high risk with a 2006 the gap analysis to equity percentage results in – 150 % and

increased to – 375 % by 2007. This means with any rise in the interest rate the bank will face

huge liquidity problems.

Analysis and Results

From looking at the consolidated balance sheets for Glitnir (2007-2008) and

IslandsBanki (2008-2009), the investments that Glitnir engaged in, and the graphs that

indicates the declining performance of the bank since 2006, one can say that there are three

main reasons for the fall of Glitnir bank (Refer to Appendix). These reasons are engaging in


risking investment activities, maintaining low capital ratio, and financing activities on too

much debt. This section will explore these three reasons in details in order to have a better

understanding of the essence of the problem. It will also discuss how the bank was saved by

the government.

Risky investments

Glitnir offers universal banking services including investments. Glitnir engaged in

extensive investments activities, some being international, that were risky in order to

maximize its returns. Unfortunately, when the economic crisis occurred, Glitnir was not able

to keep up with the rapid changes and the bank lost a lot of money which caused financial

problems. From the many investments, Glitnir focus was, and still, on sustainable energy and

the sea food sector. It is worth mentioning that the EU is the largest seafood market for

imported fish; where Glitnir also invests. According to FAO, the EU imposed regulations that

imported fish should be certified from the fishers’ authorities which can create challenges and

drop in the EU market share. In addition, it is stated that although fish exports grew in 2008,

estimates indicate that it declined in 2009 due to the current economic conditions. These facts

illustrates that market of the seafood is risky and not stable (FAO, 2010).

In addition, the sustainable energy sector requires extensive capital investments in

order to secure enough resources, conduct research, and implement projects. The islandsbanki

website states, “Financing for geothermal projects is relatively capital intensive to start with.

To get financing is also more difficult the earlier the development stage of the project. This

reflects the risks of geothermal projects until the resource has been proven (islandsbanki,

2009).

By examining the numerical data from Glitnir Hedge Fund 2007 annual report, it is

obvious that the bank took risky decisions which led to economic failure (refer to Appendix).

Firstly, the securities portfolio in hedge fund report included shares purchases from Goldman

Sachs Group, GlitnirBanki HF, LandsBanki Islands, and several energy investments such as:

Sun Power Corp and XTO Energy. By investing in Goldman Sachs which is faced supreme

mortgage crisis in 2008, Glitnir which was nationalized in 2008, and the energy sector which

requires extensive capital investment, Glitnir was exposed to risky investments that led to

deterioration in its financial position (Audited annual report, 2007).

Capital Ratio

According to the text book, holding sufficient capital prevents bankruptcy and satisfies

central bank obligations (Mishkin, 2007, p. 231). When calculating the capital ratio for June

2008, a month before announcing the nationalization, it was only 5.19%. This low percentage


suggests that when the bank lost its assets due to the risky activities and the economic crisis

conditions, it did not have adequate capital level to support this lose which led to insolvency

as well.

However, the capital ratio for December 2008 increased 10.34% which is an indicator of

movement towards safety to avoid problems in the future.

Liabilities

The loan to asset ratio in 2006 was 78.94% and 76.41% in 2007. By looking at these

figures, it is noticeable that Glitnir depends on debt, and more importantly international debt,

to finance many of its activities which make Glitnir in a sensitive situation if international

markets face any difficulties. However, it is also indicates that investors trust the bank and

are willing to invest in it. Unfortunately, when the financial crisis started in 2008, the bank

was unable to meet its obligations which led to bankruptcy.

The cash ratio is a measure of liquidity which indicates the amount of cash available to

meet the short term obligations. Since Glitnir relays mostly on debt, it should have enough

cash to be able to meet these obligations in case of an emergency. On the contrary, the cash

ratio does not exceed 2% which puts Glitnir in a sensitive situation if any sudden events arise.

As illustrated in the previous section regarding GAP analysis: for a negative Dollar Gap

Ratio, an increase in the interest rate will lead to a short-term liquidity problems. When

calculating Dollar Gap Ratio/Equity capital to get the percentage, it is obvious that there is a

major increase from -133% in 2006 to -373% in 2007. This shows that the default risk is

increasing as a result of the GAP increase. When interest rates started to increase

dramatically in 2008, the bank was not able to meet its liabilities which resulted in

insolvency.

How did the bank overcome the situation?

Since Iceland is considered a small economy, Glitnir engaged in international activities

looking for opportunities to expand. As a result, when the economic activities deteriorated

Glitnir’s financial strength was affected, as mentioned above, which led to the nationalization

of the bank. According to the Guardian Website, in September 2008 the Icelandic

government bought 75% of the bank’s shares in order to support its capital. In addition, the

name of the bank was changed to islandsbanki as a step to gain trust by referring to a well

known name. However, in October 2009 the bank’s Resolution Committee announced that

95% of the shares will be held by the creditors, while only 5% will be held by the

government. (Islandsbanki, 2010)


Based on the comparison between the balance sheets of June 2008 and December

2008, it is clear that Islandsbanki is now starting to build up again after the huge losses in

2008. One can notice the significant decrease in all the balance sheet elements: assets,

liabilities, and equity. This indicates that the bank is not as large as it used to be. The

decrease in liabilities from 3,662,362M to 589,973M and in the increase in the capital ratio to

10.34% shows that the bank is considering safety measures and not engaging in risky

activities.

Conclusion

No one can deny the fact that the financial crisis destroyed the whole economy of

Iceland dramatically. The bank’s strategy which was based on expanding to reach

international markets made it impossible for Glitnir to survive in this environment. Glitnir

engaged in several risky investments to maximize its returns which led to insolvency. The

banks’ major investments were in the seafood and sustainable energy sectors which require

intensive capital investments. In addition, the hedge fund annual report 2007 states that the

bank invested in risky securities which made the bank exposed to default risk. Another factor

that affected the bank negatively is maintaining a low capital ratio which did not allow the

bank to recover from the loss of its assets due to the current financial crisis at that time. The

third factor was that Glitnir held too much debt which resulted in bankruptcy because interest

rates increased dramatically in 2008 and the bank was not able to meet its liabilities. Since

Iceland is a small economy, the government saved Glitnir in order to sustain its economy. 95

percent of the bank is now owned by its creditors who appointed the new management team

(islandsbanki, 2008). The new team is following more secure strategies in order to gain the

market’s trust once again. They reduced the liabilities and increased the capital ratio in order

to prevent bankruptcy once again.

Recommendations

Based on our research paper, the following recommendations are advised to prevent any

future problems that IslandsBanki may face:

The bank should divide its investments into more diversified markets or sectors

instead of only focusing on the financial, energy, and seafood markets. By doing this

the bank will lower its risks because the bank will be putting its eggs in different

baskets.

The bank should keep enough excess reserves to cover any future debts or sudden

losses due to the rapid fluctuations in the financial markets (ex. financial crisis).


Based on what was mentioned in the research paper, the bank should maintain a high

capital ratio to help avoid any future bankruptcy.

The bank should not depend mostly on debt to finance its operations in order to not

face financial distress that might lead to insolvency.

The lessons learnt from “Glitnir’s bankruptcy”

This insolvency came to prove once again that the higher the risk, the higher the

return. Therefore, if a bank chooses to take higher risk, it should weigh the

opportunity costs (lower returns, safer investments vs. higher returns, riskier

investments) and study the investments carefully.

The government plays a major role in stabilizing the economy. As mentioned in the

paper the Icelandic government decided to step in to save the economy by buying

75% of the bank's stock (islandsbanki, 2008).


References

Audited annual report, Initials. (2007, 12 31). Glitnir hedge fund. Retrieved from

http://www.glitnir.lu/servlet/file/hedge_311207.pdf?

ITEM_ENT_ID=8909&COLLSPEC_ENT_ID=156

Beranek, B. (n.d.). Iceland’s banking meltdown: analyzing the portents of a financial storm.

Retrieved from iibf.ieu.edu.tr/.../icelands-banking-meltdown-analyzing-the-portents-

of-a-financial-storm.doc

FAO. (2010, April 26). New market access rules, economic crisis affecting seafood industry.

Retrieved from http://www.fao.org/news/story/en/item/41427/icode/

Islandsbanki. (2008, 09 29). The Government of iceland acquires 75 percent share in glitnir

bank. Retrieved from

http://www.islandsbanki.is/english/about-islandsbanki/news/detail/item14983/

The_government_of_Iceland_acquires_75_percent_share_in_Glitnir_Bank/

Islandsbanki, Initials. (2009, 12 29). Investment case . Retrieved from

http://www.islandsbanki.is/english/industry-focus/sustainable-energy/geothermal-

energy/investment-case/

Islandsbanki. (2010, 01 25). New board of directors appointed for Íslandsbanki. Retrieved

from http://www.islandsbanki.is/english/about-islandsbanki/news/detail/item56523/

New_Board_of_Directors_appointed_for_Islandsbanki/

Mishkin, F. S. (2007). The Economics of Money, Banking, and Financial Markets. Pearson

Education International.

Þórisson, Hermann. (2006). Kepler teather & greenwood merrion. Glitnir Bank, Retrieved

from http://www.landsbanki.is/Uploads/MailList/Docs/GLB_06_Dec.pdf

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