What it takes to lift capital controls, eight years after imposing them

Iceland put comprehensive capital controls in place in November 2008 and did not free its own residents from them until March 2017. The delay was not administrative. Two large blocks of krona were waiting at the exit, and until both were made safe, opening the door would have caused the crisis the controls were built to prevent.

Key Takeaways

• The controls came in November 2008, as part of the programme agreed with the International Monetary Fund, to stop the currency falling further.
• The obstacle to removal was a stock of krona owned by people who wanted out: offshore holdings and the failed banks' domestic assets.
• The estates were settled on published stability conditions, with a tax as the backstop if they refused.
• The offshore stock was reduced through a long series of auctions and, finally, direct purchases.
• Only then were residents freed, in stages, in October 2016, January 2017 and March 2017.

What were the controls actually stopping?

Money leaving.

The Central Bank's own account is direct about the scale of the problem. In the month before the controls, around 90 per cent of the banking system collapsed when Iceland's three large cross-border banks failed. The currency had already fallen sharply earlier that year, and fell again during the collapse. The controls were part of the economic programme developed with the Fund, and their stated purpose was to help stabilise the exchange rate.

The specific danger was a stock, not a flow. Liquid krona owned by foreigners, left over from carry trade and other inflows, came to around 40 per cent of gross domestic product. Iceland's foreign exchange market is small, and the Central Bank has said that letting that money convert and leave would have caused a further collapse in the currency.

The controls also did work that is easy to overlook. They let a large fiscal deficit be financed at home while the sovereign had no access to foreign markets, and they bought the time needed to repair balance sheets and rebuild the financial system.

Why did removing them take more than eight years?

Because the controls worked.

The Central Bank has put it plainly, and it is the genuinely surprising part. Preserving Icelandic asset prices and supporting the recovery also preserved the value of the positions waiting to leave. Had the controls not been imposed and domestic balance sheets not been repaired, those positions would have been worth far less, and would probably have left years earlier at a fraction of their value.

Instead they held their value and stayed. By 2016 the Central Bank put the domestic assets of the old banks at 25 per cent of gross domestic product and the offshore krona stock at around 15 per cent. Letting either leave freely would have produced a new currency crisis.

What is the offshore krona problem, exactly?

Fund staff described liquid offshore krona in 2013 as assets held by foreigners and locked in when the controls were imposed, held as Treasury and Housing Financing Fund bonds and bank deposits, amounting to 23 per cent of gross domestic product. The estates of the old banks were a second block, estimated then at 40 to 50 per cent of gross domestic product, part of it liquid. A third category was harder to size: the same staff noted there was no reliable estimate of what residents themselves would move once they were allowed to.

The authorities therefore worked in a deliberate order. The first phase opened exit channels for offshore krona to shrink the overhang. The second phase, removing restrictions on residents, could only begin once that and other conditions were in place. Non-resident positions came first because they were the ones that could leave in a single wave.

The estates were a late complication. The split between the old and new banks was only finished at the end of 2010, and it was not a clean domestic and foreign split: the estates held significant domestic assets while few of the claims against them were domestic. They came under the controls in March 2012.

What conditions had to be met?

Iceland published three versions of its liberalisation strategy, in 2009, in 2011 and in June 2015. The third is the one that worked, and it rested on a stated principle and a set of criteria.

The principle was that solutions had to be comprehensive, cautious and clearly communicated, so controls could come off without undue risk to economic and financial stability. Comprehensive meant reducing the outflows tied to resolving the failed banks. Cautious meant sequencing, so the largest obstacles were solved one at a time.

The economic conditions for freeing residents were named in advance: adequate foreign exchange reserves, market access for the sovereign and the banks, and a well-balanced and growing economy. Any solution also had to limit the risk to Government finances and credit ratings, avoid moving private losses onto the public, let the exchange rate reflect economic fundamentals rather than legacy positions, and prefer simplicity and finality over complexity.

By the last stage those conditions were visible in the numbers. The Ministry of Finance and Economic Affairs reported reserves of about 800 billion krona at the end of February 2017, built on a current account surplus worth 8 per cent of 2016 gross domestic product, with Iceland's net external position positive for the first time on record.

How were the failed banks' estates settled?

By giving them a choice with the same answer at both ends. Under the first option, an estate received exemptions from the controls so it could complete composition and pay its creditors, provided it met stability conditions that fully offset the effect on the exchange rate and the reserves. That meant paying stability contributions through the transfer of krona assets, lengthening the maturity of the estate's foreign currency financing of domestic banks, and repaying Government and Central Bank support.

Under the second option, a tax would be levied on the estate that fully offset the balance of payments effect of the resolution. The Central Bank has described that tax as the backstop that made the first option workable.

Every estate chose to meet the stability conditions. That is what a well-designed backstop looks like: it is not used.

How was the offshore stock cleared?

Slowly, and then by purchase.

Auctions had been running since the second strategy in 2011. Twenty-one had been held by June 2016, and a further single-price auction was announced for 16 June 2016 against a total eligible stock of 319 billion krona. Participation was voluntary throughout, and some holders preferred to wait.

Legislation then did what the auctions could not. In 2016 Parliament passed a law segregating the remaining offshore krona, so controls on residents could come off regardless of how many holders had sold. Banks holding those accounts had to buy certificates of deposit from the Central Bank for the same amount, at an interest rate initially set at 0.5 per cent and reviewed annually. Holders kept what they held, and there was no forced debt exchange.

The last step was direct. On 12 March 2017 the Central Bank announced agreements to buy close to 90 billion krona of offshore assets, cutting the stock from about 195 billion to about 105 billion. Holders who had not joined were offered the same terms in April.

How were residents freed?

In three steps, each written into law. Act No. 105/2016 amended the Foreign Exchange Act No. 87/1992 in two stages; the third was a new set of Rules.

What stayed was narrow: derivatives trading for purposes other than hedging, foreign exchange transactions between residents and non-residents with no financial undertaking in the middle, and lending to non-residents for carry trading. Who may deal directly in a market is a separate question from whether money may leave, which opening a closed onshore market sets out. Offshore krona remained under its own separate law, and a special reserve requirement on new foreign currency inflows stayed in force to manage the inflows that liberalisation itself invited.

The general lesson

A capital control is easy to impose and hard to remove, and the difficulty is not legal. Repealing a rule takes an afternoon. What takes years is making sure the money it has been holding in place will not all leave at once.

So the exit is a balance-sheet problem. You have to know who is waiting and how liquid their holdings are, shrink each block with the most mobile money first, and build reserves to absorb whatever still moves. Iceland did that in public, on a published strategy, and it still took eight years.

Where to look next

The AUD to ISK page carries the live reference rate and a short block on what kind of money the krona is. For the case of a currency restrictions keep out of the offshore market altogether, why some currencies have no offshore market sets out what has to be true before a currency can trade outside its own borders.

Sources

• Már Guðmundsson, Governor of the Central Bank of Iceland, Lifting capital controls in Iceland, 26 May 2016 - the November 2008 imposition and its rationale, the 40 per cent overhang, the estates brought under the controls in March 2012, the three strategies and the 2015 criteria, the stability conditions and the tax backstop, the auctions, and the certificates of deposit
• Ministry of Finance and Economic Affairs, Progress of the Plan for Removal of Capital Controls, 25 April 2017 - the three liberalisation stages with their dates and ceilings, the restrictions that remained, the March 2017 offshore purchase, and the end-February 2017 reserves and current account surplus
• International Monetary Fund, Iceland 2013 Article IV Consultation, Selected Issues, Country Report No. 13/257 - the two-phase ordering, offshore krona at 23 per cent of gross domestic product and what it was held as, the estates at 40 to 50 per cent, and the absence of an estimate for resident outflows

General information about capital controls and how they are removed. Not financial advice, and not a recommendation of any product or institution. Reviewed by the Tradergy editorial team, September 2026.