Negative outlook for Icelandic banking system

The fundamental credit outlook for the Icelandic banking system remains negative, reflecting the significant challenges still lying ahead in terms of rebuilding the sector, Moody's Investors Service said in its new Banking System Outlook on Iceland.
As a result of the magnitude of the financial crisis Moody's has major concerns about future asset quality.
"The Icelandic credit environment has weakened significantly as demonstrated by the number of corporate insolvencies, which more than doubled in the first four months of this year from the respective period of 2008. Also, the debt servicing capacity of Icelandic households is rapidly declining, driven by rising unemployment, weaker house prices and a weakened Icelandic krona. Therefore, we expect a significant increase in problem loans in the near future," said Kimmo Rama, a Moody's Vice President/Senior Analyst.
Following the collapse of the country's three largest banks in autumn 2008, Moody's notes that the banking system is now effectively owned by the government. All domestic assets were transferred to newly created banks owned by the government, while all problem assets and foreign liabilities were kept in the failed banks. Over time, to compensate for the transfers, the new banks will issue bonds or other financial instruments to the failed banks, equivalent to the surplus of assets over liabilities at fair value.
"Undoubtedly, the next key challenge for the Icelandic banking system will be the finalisation of the asset and liability valuations of the failed banks and the further restructuring of the banking system to help to regain its credibility, both domestically and internationally," explained Rama.