History and premises

Background

The development of the Icelandic financial system has reflected the political and economic evolution of the country from a dependency of the Danish Crown into a modern high-income republic. The government was closely involved in the early development of banking in Iceland, and the first bank was the state-owned Landsbanki Íslands (National Bank of Iceland) which was established by law in 1885. It received as capital a small issue of treasury notes, which were freely convertible into Danish crowns. The second bank, Íslandsbanki (Bank of Iceland), was a private joint-stock company mostly owned by Danish investors. It started business in 1904 and operated under special legislation giving it the right to issue notes backed by gold. After sovereignty in 1918 political opinion shifted against leaving the right to issue notes in the hands of a foreign-controlled bank. The power to issue notes was therefore gradually moved from Íslandsbanki to the state-owned Landsbanki.

Monetary policy did not play an active part in the management of the Icelandic economy in the early postwar period. Landsbanki had had the sole right since 1927 to issue notes, as well as being the main commercial bank with a market share of well over half of all deposits in banks and savings banks. With such strong commercial banking interests and limited central banking functions it is only to be expected that monetary policy should have taken a back seat in Landsbanki´s activities. An important step was taken to change this situation in 1957 when the note-issue department was given separate management as well as new instruments for regulating the liquidity of the banking system. However, this was obviously a halfway house, and in 1961 the step was finally taken of creating a fully autonomous Central Bank out of Landsbanki´s central banking department.


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  • Establishment of the Central Bank 1961

    The Central Bank of Iceland, Seðlabanki Íslands, was established by an Act of Parliament in April 1961. It is a state-owned institution administered by a Board of Governors. The Board of Governors consisted of three members appointed by the Minister. From 2009 there has been one Governor which is appointed by the Minister of Finance and Economic Affairs. There is also a seven-member Supervisory Board, elected by the Alþingi (Parliament), which acts in a supervisory and advisory capacity.

    The Central Bank was assigned most of the traditional central banking functions, including the sole right to issue notes and coins and manage the foreign exchange reserves. The Central Bank acts as banker to the government and was for a period allowed to grant short-term credit to the Treasury. It was also given powers to regulate interest rates and also to influence the liquidity of the banking system both through short-term lending and by requiring the banks to hold blocked reserves with the Central Bank. Supervision of the operations of all institutions authorised to accept deposits from the public was also put in the hands of the Central Bank. <9 />

    Although formally independent, the Central Bank was required by law to support the economic policy of the government. This was interpreted as meaning that the Bank could not make major changes in, for example, interest rates or reserve requirements, if these were objected to by the government. During the sixties no severe problems arose in policy coordination between the Bank and the government. This changed after inflation accelerated in the seventies, particularly following the oil crises, and monetary policy came under increasing strain. Interest rates, through government policy, were kept relatively low in spite of accelerating inflation, leading to strict rationing of credit and the erosion of monetary savings.

    New role in deregulated finance market 1984

    A radical change in monetary policy did not take place until after 1984 when the first steps were taken to deregulate interest rates. Two years later, in 1986, the Central Bank Act was revised, abolishing the Bank's powers to regulate the interest rates of commercial banks and savings banks. This quickly led to greater competition in financial markets and initially to rising interest rates. After these changes it became a priority task of the Central Bank to encourage the development of active markets in bonds and short-term government paper. An important step in that process was an agreement between the Bank and the Treasury limiting government access to credit from the Central Bank. Instead, the Treasury started selling both Treasury bills and bonds at regular auctions, laying the foundation for more effective money markets and market-determined interest rates.

     

    The 1986 Act also strengthened the position of the Bank Inspectorate of the Central Bank, a supervisory department which was also given responsibility for the supervision of non-bank financial institutions.

     

    Various changes took place during the last decades of the twentieth century. New markets were introduced and the Central Bank either took the initiative or participated actively in making these markets, amongst others the Iceland Stock Exchange, markets for long- and short-term paper and the currency market. Currency movements were liberalised. In 1999 the banking supervision was moved to a new Institution, the Financial Supervisory Authority (FME).

  • New Central Bank Act 2001

    In May 2001, a new Act on the Central Bank of Iceland entered into force. The main elements of the new Act are as follows:

    The main objective of monetary policy is to maintain price stability. With the approval of the Prime Minister, the Bank is authorised to adopt an inflation target as a framework for the conduct of monetary policy. An inflation target had been adopted on March 27, 2001 through a joint declaration of the Government and the Central Bank. By law, the Bank shall also promote other objectives, such as an efficient and safe financial system, including payments systems, and other tasks consistent with its role as a central bank. The Bank shall support the economic policy of the Government as long as it does not deem it inconsistent with the objective of price stability. The Act thus gives instrument independence to the Central Bank. The de facto ban on credit to the public sector that has been in force since the early 1990's becomes law with the new Act. Exchange rate policy is decided by the Central Bank, subject to the approval of the Prime Minister, but it has to be consistent with the main monetary policy objective of price stability. A lender of last resort function is provided for.

  • Accountability and independence

    Monetary policy decision-making authority was then vested in a Board of three Governors. They should be appointed by the Prime Minister for seven-year terms with possible reappointment for a second seven year-term. The Minister specifically appointed the Chairman of the Board, also for a seven-year term with the possibility of one reappointment. 

    In order to ensure the highest degree of professionalism in the shaping and implementation of monetary policy, the Act instructed the Governors to set internal working rules on the preparations of, arguments for and presentation of monetary policy decisions. The rules shall, inter alia, cover the internal procedures to be followed, what information and indicators should be primarily relied on and which staff should participate in the process, although ultimately the decision-making authority rested with the three Governors. Minutes of meetings did not have to be published and the Bank was not required to disclose the position of individual Governors. The Bank must, on the other hand, publicly explain in detail its monetary policy decisions and the rationale behind them. The Bank is obliged to issue an annual report detailing its activities and quarterly reports on monetary developments and policy and monetary measures. The process described above was to enhance the transparency of monetary policy.

    The role of the Supervisory Board was spelled out more clearly than before and its membership was expanded to seven. It supervises the activities of the Bank and must approve various rules which are issued by the Governor(s), including those on the internal working procedures described above. The Supervisory Board also has to approve the operating budget for the Bank at the beginning of each year.

     

    The Bank was relieved of expenditure obligations which more appropriately belong in the fiscal budget.
    The Act provides for a build-up of the Bank's capital and reserves. When they are below a certain level defined in the bill, the Bank shall pay a third of its annual profit to the Treasury. Once they have reached the stipulated level, two-thirds of the profit shall be paid to the Treasury.

    In sum, the Bank was granted instrument independence, its financial independence is better ensured and the legal demands on transparency and accountability are strengthened.

    The new Act is explained further in Monetary Bulletin 2001/3.

  • Changes in 2009 and later; Monetary policy committee, one governor and increased emphasis on financial stability

    In February 2009, the Act on the Central Bank was further amended. The main changes were that one Governor (and one Vice Governor) was appointed instead of three and that a Monetary Policy Committee, consisting of five members makes the decision on policy interest rates. The Act on the Central Bank was amended in July 2013, and the Central Bank was given an explicit mandate of promoting financial stability. A Financial Stability Council was established in 2014. The chairman of the Council is the Minister of Finance and Economic Affairs. A Systemic Risk Committee working for the Financial Stability Council was also established in 2014. The Governor of the Central Bank chairs the Systemic Risk Committee. 

  • New Central Bank Act 2019


    As of 1 January 2020, the Central Bank is responsible for the tasks entrusted by law and Governmental directives to the Financial Supervisory Authority, and the financial supervision is now part of the Central Bank. The Bank shall therefore monitor supervised entities to ensure that their activities are in compliance with the law and with Governmental directives, and that they are in other respects consistent with sound and appropriate business practices.

The Central Bank of Iceland building on the hill at Arnarhóll is one of the most distinctive buildings in the heart of the Reykjavík city centrum. The cornerstone of the building was laid by the then-current president of Iceland, Ms. Vigdís Finnbogadóttir, on 6 May 1986. The Bank moved into its new headquarters in 1987, after having shared facilities with Landsbanki Íslands in three buildings located in Austurstræti and Hafnarstræti. For the most part, the building at Arnarhóll is custom-designed for the operations of the Central Bank and related entities. It is over 13,000 square metres in size and consists of the main building, which is five storeys tall from the Arnarhóll entrance and six storeys on the Skúlagata and Kalkofnsvegur entrance, and an adjacent building of two to three storeys. A subterranean basement lies beneath the entire building.

The building was designed by architects Guðmundur Kr. Guðmundsson and Ólafur Sigurðsson. The outer walls that face Kalkofnsvegur call to mind a fortress, reflecting the emphasis on durable long-term construction and little need for maintenance. The exterior is clad in part with aluminium, making the Bank headquarters one of the first buildings in Iceland to feature aluminium siding. The exterior of the adjacent building and the pillars of the tall portion of the main building are clad with gabbro from Hoffell in Hornafjörður fjord.

The construction of the Central Bank building has a long history. The Bank shared facilities with Landsbanki Íslands for nearly three decades. In 1978 it bought a small building on a large lot at Einholt 4 in Reykjavík, in order to merge its storage facilities, which were located in three different places in the city. A three-storey building some 2,000 square metres in size was built on this lot. This building now houses the majority of the Bank’s archives and library, together with documents from the Central Bank and National Museum of Iceland’s joint Numismatic Collection and the garages for the Bank’s motor vehicles.

Preparation for the construction of the Bank’s new headquarters moved forward in 1981, with the conclusion of an agreement with the City of Reykjavík providing for a swap of a lot owned by the Central Bank in Sölvhólsgata and the Swedish freezer plant lot at the northern end of Arnarhóll. Early in 1982, the City of Reykjavík Planning and Building Committee approved the architectural drawings for the new bank headquarters, and construction began. A celebration was held to commemorate the new construction in July 1984, and work began on exterior insulation and cladding. The cornerstone was laid by the president of Iceland, Ms. Vigdís Finnbogadóttir, on 6 May 1986.
During the construction phase, the City of Reykjavík and the Central Bank held a competition for ideas on the role and development of Arnarhóll, with an eye to beautifying the city and honouring Ingólfur Arnarson, Reykjavík’s first settler.

The building has housed other institutions in addition to the Central Bank. The Icelandic Banks' Data Centre has maintained offices there, and the National Economic Institute of Iceland was housed there during its tenure of operation.

Central Bank of Iceland