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European ruling teaches hard lesson in cross-border banking

Iceland was dumb in the lead-up to the 2008 financial crisis, but the U.K. and Holland were dumber. That's the implicit message of a ruling by the European Free Trade Association (EFTA) court on Jan. 28. In a certain sense, the verdict is a reward for the abject failure of the Icelandic government to regulate its banks. But the EFTA court rightly concluded that the British and Dutch trust in a shaky overseas sovereign was even more idiotic.

The court's main task was to judge whether Iceland had been in breach of its responsibilities in leaving U.K. and Dutch depositors in the lurch when the biggest Icelandic bank, Landsbanki, collapsed in 2008. The two countries' irate taxpayers would no doubt say yes, because they had to fork out their own resources to make depositors whole. So, perhaps, would many neutral observers.

The court's decision to instead find in Iceland's favour shouldn't mean too much financial pain for Britain or Holland. The Landsbanki estate has already made good on 50 per cent of the money owed to the foreign depositors, and the administrators are confident that the rest can be found. What the judgment does administer, however, is an object lesson in the cold realities of cross-border banking.

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Before the European Commission wised up in 2009 and toughened the rules, states under EFTA's remit had to have deposit guarantee schemes, but there was considerable diversity in how capacious they had to be. Officials in London or the Hague either didn't notice Iceland's banking sector was ten times larger than its GDP, or they did but assumed Reykjavik would help shoulder the burden in a crisis. As it turned out, it didn't.

EFTA's cold blast of reality comes as global regulators are trying to fashion workable "resolution plans" to deal with the failure of giant cross-border banks. That requires give and take and a collegiate approach, qualities not usually in abundance on the international stage. Britain and Holland's bloody nose will make states tread even more warily. But if it means whatever ends up being drafted better protects taxpayers, that may be no bad thing.

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