Economic Activity in Turbulence: Banks and Financial Markets

Abstract

In the aftermath of the failure of the Icelandic financial sector, embedded flaws of all the main pillars of the Icelandic economic system became evident. Individuals and institutions alike failed so that the system itself did not deliver the outcome it was set to do. This article presents a survey of the main stakeholders of the financial system and maps out the incentive structure which defines the system and its outcome. The main conclusion is that the institutional structure of Iceland needs significant repairs so that Iceland can be considered favourable place for investments. The main weaknesses identified by this paper lie in the judicial system, given the lack of specialization among judges, as well as class-action suits being illegal; the low turnover and small size of the stock market; and a weak governance structure of firms. Incentive schemes of the fallen Icelandic banks proved also to be highly flawed in terms of protecting the interests of the minority shareholder.