Iceland won a sweeping victory in a court fight over its responsibilities to foreign depositors in the Icelandic bank Landsbanki, which failed in 2008.
The court of the European Free Trade Association Monday said Iceland didn't breach European Economic Area directives on deposit guarantees by not compensating U.K. and Dutch depositors in Landsbanki's online savings accounts, known as Icesave accounts.
The EFTA Surveillance Authority, or ESA, which brought the case against Iceland, had claimed that Iceland should have made sure U.K. and Dutch savers who lost money on Icesave got repaid from deposit insurance.
U.K. and Dutch authorities compensated their own savers.
The directive, part of EU rules to which Iceland subscribes, "does not lay down an obligation on the State and its authorities to ensure compensation if a deposit guarantee scheme is unable to cope with its obligations in the event of a systemic crisis," the ruling said.
The ruling of the EFTA Court is final and can't be appealed.
It was a victory for Iceland--and one that may have ramifications throughout the European Union. Iceland isn't a member of the EU, but it is part of the larger EEA, a group of countries that agree to follow the EU's common-market rules. The EFTA Court's judgment doesn't bind the EU's highest court, the European Court of Justice, but it does establish a precedent for jurisprudence in the wider EU system.
The EFTA Court sets up a vexing question: If deposit-guarantee programs don't protect everyone, are they really effective? That issue was raised by the European Commission, the EU's executive arm, which joined the case against Iceland. European deposit-guarantee programs, if they have any funds at all, hold a tiny fraction of the insured deposits in the system. Their typical use is providing insurance in case a small number of banks collapse--not to bail out a whole system's worth of depositors.
In the U.S., the Federal Deposit Insurance Corp. holds just over 1% of insured deposits--but the FDIC is backstopped by the credit of the U.S. government.
Because its banks opened Internet arms seeking deposits from foreigners, Iceland had an unusually high proportion of foreign depositors in the system. In the euro zone, Cyprus--which is currently negotiating an EU bailout--has plenty as well. Of its EUR70 billion ($94 billion) in deposits that don't come from other banks, nearly 40% come from outside Cyprus. Germany has argued that some bank depositors in Cyprus shouldn't get all their money back.
Iceland didn't force losses on domestic depositors. In the windup of the banks, the authorities put domestic deposits and assets into new "good" banks and left foreign deposits in the old, insolvent banks. The EFTA Surveillance Authority argued that Iceland violated nondiscrimination rules by treating domestic depositors differently.
The court agreed with Iceland that the transfer didn't break the rules.
The EU's common-market rules require that every country establishes a deposit-guarantee program providing a minimum level of compensation to savers in case of a bank failure. Iceland's banking collapse took down all the island's major banks, and the Icelandic deposit-guarantee fund didn't have enough money to pay out insurance.
At the core of the Icesave case is exactly what a country must do in such a total failure. Iceland said its obligation was simply to make sure that a reasonable guarantee plan existed. The U.K. said a country is obliged to make sure that insured depositors are actually paid.
The Icelandic government expressed "considerable satisfaction" that the country's stance had prevailed in the Icesave case. "The EFTA Court ruling brings to a close an important stage in a long saga," the foreign ministry said in a statement.
A spokesman for the European Commission, Stefaan De Rynck, said the Commission would "maintain its interpretation" of the deposit-guarantee requirements in the 27 member states of the EU, where Mr. De Rynck says the guarantees must "also apply in the event of a systemic crisis." It is unclear how an EU court would react. The Commission's stance leaves a rift between the EU countries and the three EFTA countries--Iceland, Norway and Liechtenstein--on what are supposed to be common rules.
U.K. authorities said they were still considering their response, while Dutch authorities said they were disappointed by the ruling and would study its consequences.
Eirikur Bergmann, a political scientist at Bifrost University in Iceland, said the U.K. and Dutch authorities had been pushing Iceland to pay the interest on the compensation already paid out to the British and Dutch depositors.
"That is completely dismissed," Professor Bergmann noted. He added that the fact that the ESA was being forced to pay all Iceland court costs indicates what a vindication this ruling is for Iceland.
"The ruling marks the end of a torturous debate lasting almost four years," he said.
--Ainsley Thomson in London and Maarten Van Tartwijk in Amsterdam contributed to this article.
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