Europe Economy

Let the banks fail? Iceland says Europe got it wrong

Iceland capital controls signal 'sickness': Fin Min
Iceland capital controls signal 'sickness': Fin Min

The European Union has failed to heed the lessons from Iceland's banking crisis in 2008, Bjarni Benediktsson, the finance minister of Iceland, told CNBC on Tuesday.

Iceland opted not to offer state bailouts to troubled lenders during its crisis, meaning its three biggest lenders — Glitner, Landsbanki and Kaupthing — entered administration at the end of 2009.

Speaking from the sidelines of a finance ministers' meeting in Luxembourg, Benediktsson said that struggling peripheral euro zone countries in particular would be in better shape if they had followed Iceland's lead.

"The state does not always have to intervene when the private sector is in a problem. And it does not always make sense to take private debt and make it public. This is something that we did not do in Iceland," Benediktsson told CNBC.

(Read More: Iceland's biggest worry? The euro zone: Premier)

"Now in 2013, we can see the difference," he added.

Iceland, whose economy was historically based around fishing, became heavily involved in financial services following the deregulation of its banking sector in 2001. Glitner, Landsbanki, and Kaupthing all borrowed heavily to fund acquisition sprees, and owned assets equivalent in total to around nine times the Iceland's gross domestic product (GDP) by the end of 2007.

However, the banks became unable to refinance their short-term debt following the collapse of Lehman Brothers in 2008, and all three subsequently collapsed.

In contrast, governments in other European countries, including Ireland, Spain and the U.K., used taxpayers' money to sure up their banks when faced with a similar problem. British banks RBS and Lloyds both received state aid, along with Spanish lender and Ireland's Anglo Irish Bank.

Benediktsson's words on Tuesday echoed those of his prime minister, Sigmundur Davíðo, who told CNBC in September that the euro zone hasn't learnt from the Icelandic experience.

"The European banks survived but haven't learnt from the experience. They are still functioning on the regulations that brought down the Icelandic banks," Davíðo said.

Iceland's recovery was aided by the depreciation of the Icelandic krona, Benediktsson added, whereas struggling euro zone nations like Cyrpus are unable to benefit from the flexibility of having their own currencies.

(Read More: China Tycoon Defends Bid for Chunk of Iceland)

In the aftermath of its crisis, unemployment rose in Iceland, growth shrank, and inflation hit 20 percent. However, there are now signs the economy is recovering, with 1.9 percent growth posted in the first half of 2013, and unemployment back below 4 percent. Iceland's households and businesses have also deleveraged significantly, with corporate debt now down to 150 percent of GDP, half of its peak.

"We maintained relatively low unemployment. We still have low unemployment, whereas some other countries, the adjustment has to come through the labor market, which can be very difficult in many aspects," Benediktsson said.

By's Matt Clinch. Follow him on Twitter @mattclinch81