Icelandic banks feel the chill as credit crunch stretches north

Icelandic banks feel the chill as credit crunch stretches north

The following correction was printed in the Observer's For the record column, Sunday April 6 2008

Below, we reported that depositors with an Icelandic bank such as Icesave or Kaupthing first need to claim compensation from the Icelandic deposit protection scheme, should they go under. This is true for Icesave but Kaupthing point out that they are covered by the UK Financial Services Compensation Scheme, under which the first £35,000 of individual savings is protected.

On one internet talkboard last week, someone who had savings in Icelandic bank Icesave was telling his fellow website users he had just withdrawn it all and put it into Northern Rock. The reason? Because he felt it was a safer bet. The global creep of the credit crunch has spread to Iceland: last week its central bank was forced to increase interest rates dramatically in an effort to fend off a full-blown economic crisis, raising fears the country's banking sector is in danger of collapse.

One cannot but be struck by the irony of this gentleman's decision: six months ago savers were lining up to withdraw money from the Rock - and a lot of that was going into Icesave, which had (and still has) some of the best rates on offer. Now anyone who has savings with either Icesave or the other Icelandic bank that takes UK deposits, Kaupthing, might understandably be feeling a little jittery about the safety of their cash. So what to do?

Credit ratings agency.....continued below

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Moody's says it believes the chance of Icelandic banks 'doing a Northern Rock' is low. The biggest risk for both these institutions is a run on the bank by foreign customers, as their liquidity relies heavily on overseas deposits. As someone with savings in Icesave myself, I am certainly not advocating everyone should get out now, but it is worth understanding what protections are in place.

Since the Rock debacle, the Treasury has upped its protection in the event of a bank collapsing, covering you for the first £35,000 you hold with any financial institution - and the Icelandic banks are covered by this guarantee. However, if you have deposits with a foreign lender, you have first to claim on that country's equivalent scheme. In the case of Iceland, this covers you for about the first £16,000 of your savings; the remaining £19,000 you would have to claim through the UK scheme, the FSCS. The FSCS admits this might cause delays because it has no experience of an overseas bank going under.

Although the real risk of losing all your money is small, it has never been more important to spread that risk if you do have substantial savings or if you need access to them quickly. Either that or move the lot to the new government-backed savings institution: Northern Rock.

guardian.co.uk © Guardian Newspapers Limited 2008