GLITNIR’S BANKRUPTCY1

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
 GLITNIR’S BANKRUPTCY2

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”.
 GLITNIR’S BANKRUPTCY3

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)

Return on Assets
2.00%
1.50%
1.00%
Glitnir
0.50%
0.00%
m
V N
A
tIn
o
s
c e

2006 2007

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.
 GLITNIR’S BANKRUPTCY4

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)

Loanto AssetsRatio
79.50%
79.00%
78.50%
78.00%
77.50%
77.00% Glitnir
76.50%
76.00%
tlAV
n

75.50%
e o
.T
a
L
s

75.00%
2006 2007

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)

CashRatio
2.00%

1.50%

1.00%
Glitnir
0.50%
.N

0.00%
A
eV R
C
h
tio
a
s

2006 2007

Figure 3
 GLITNIR’S BANKRUPTCY5

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)

Gap Analysis
0.00%
2006 2007
-100.00%

-200.00% Glitnir

-300.00%
G

-400.00%
C
q
u
y
lV R
p
tio
.E
s a

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
 GLITNIR’S BANKRUPTCY6

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
 GLITNIR’S BANKRUPTCY7

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)
 GLITNIR’S BANKRUPTCY8

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.
 GLITNIR’S BANKRUPTCY9

• 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).
 GLITNIR’S BANKRUPTCY10

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_perce
nt_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_Islands
banki/
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