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Reeling from the global credit crunch, the government of Iceland has nationalized two of its biggest banks and has attempted to peg its currency to stop it from entering a free fall. The island nation’s dire economic situation has spurred the Icelandic government to make a formal request Oct. 7 for a $5.43 billion loan from Russia. Icelandic Prime Minister Geir Haarde said Reykjavik has turned to its “new friend” because its more traditional allies have refused to help.
Iceland’s status as a banking destination is a recent phenomenon. More famous for its geothermal energy, woolen sweaters and fishing fleet, the North Atlantic nation became something of a banking powerhouse when its banks, which were privatized in the mid-1990s, began looking for investment opportunities abroad. By 2003, Icelandic banks had overgrown the limited domestic lending market — the country’s population is a paltry 320,000 — and launched headfirst into the business of foreign banking.
Iceland’s banks then began looking for money to expand beyond their meager domestic capital supply and into new lucrative opportunities. The fundamental problem of Iceland’s capital supply led the banks to use the “carry trade” to supplement their capital pool, which initially only relied on the country’s sizable, but ultimately limited, pension fund.
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