Iceland's banks 'need to recover'

Landsbanki, owner of Icesave, collapsed in October 2008

The recession in Iceland is set to be deeper than in most developed countries, with a large contraction in domestic demand, a report has said.

The Organisation for Economic Co-operation and Development says that for recovery to begin, the banking system needs to function smoothly again.

The Icelandic government was forced to rescue the country's three main banks last year.

But the OECD says the banks "should not stay forever in state ownership".

Glitnir, Kaupthing and Landsbanki, which owned Icesave, all collapsed in October last year.

The Icelandic authorities have since created three new banks by transferring all domestic deposits previously held by the old banks.

However, the OECD says, "while an effective temporary solution, the present set-up is not viable over time".

It says the new banks hold impaired assets and are too big.

Better supervision

"Aggressive expansion strategies in an atmosphere of ineffective supervision rendered [Icelandic banks] highly vulnerable," the OECD said in its economic survey on Iceland.

After the country's banks were privatised in 2003, they grew quickly, increasing their consolidated assets to the equivalent of 880% of Icelandic GDP by the end of 2007.

The OECD calls for more interaction between supervisors.

It says it may be necessary to merge the Central Bank of Iceland and the Financial Supervisory Authority, or at least bring them under the same administrative umbrella.

The OECD also says that if Iceland were to become a member of the European Union (EU), it should join the euro "as soon as possible, so as to reap the economic benefits".

In July, the Icelandic parliament voted to start negotiations to join the EU.

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