The Central Bank of Iceland (Seðlabanki Íslands) is an independent institution, owned by the Icelandic state but under separate administration.

The Central Bank is in charge of monetary policy implementation in Iceland and performs a wide range of functions to this end. The main objective of monetary policy is iice stability. Furthermore, the Bank is also obliged to contribute towards the Government's main economic policy objectives insofar as it does not consider this to conflict with its own goal of price stability.

In addition, the Central Bank undertakes standard central banking tasks, such as maintaining external reserves and promoting an efficient and safe financial system, including payment systems domestically and with foreign countries. It is also responsible for the issue of notes and coin, exchange rate matters and other duties, as specified in the Central Bank Act.

The Central Bank is ultimately under the administration of the Minister of Finance and Economic Affairs and a Supervisory Board. Parliament (the Althing) elects seven members to the Supervisory Board after each parliamentary election.

The Minister of Finance and Economic Affairs appoints the Governor and Deputy Governor of the Central Bank for a five-year term. Decisions on applying the Central Bank's monetary policy control mechanisms shall be taken by the Monetary Policy Committee. In other respects, the Bank's direction shall be in the hands of the Governor.

The Central Bank of Iceland was established by an act of Parliament in 1961, although the history of central banking in Iceland is much longer. The current Central Bank Act is no. 36/2001.

History
The development of the Icelandic financial system has reflected the political and economic evolution of the country from a poor dependency of the Danish Crown into a modern high-income republic. The government was closely involved in the early development of banking in Iceland, and the first bank was the state-owned Landsbanki Íslands (National Bank of Iceland) which was established by law in 1885. It received as capital a small issue of treasury notes, which were freely convertible into Danish crowns. The second bank, Íslandsbanki (Bank of Iceland), was a private joint-stock company mostly owned by Danish investors. It started business in 1904 and operated under special legislation giving it the right to issue notes backed by gold. After sovereignity in 1918 political opinion shifted against leaving the right to issue notes in the hands of a foreign-controlled bank. The power to issue notes was therefore gradually moved from Íslandsbanki to the state-owned Landsbanki.

Monetary policy did not play an active part in the management of the Icelandic economy in the early postwar period. Landsbanki had had the sole right since 1927 to issue notes, as well as being the main commercial bank with a market share of well over half of all deposits in banks and savings banks. With such strong commercial banking interests and limited central banking functions it is only to be expected that monetary policy should have taken a back seat in Landsbanki´s activities. An important step was taken to change this situation in 1957 when the note-issue department was given separate management as well as new instruments for regulating the liquidity of the banking system. However, this was obviously a halfway house, and in 1961 the step was finally taken of creating a fully autonomous Central Bank out of Landsbanki´s central banking department.

Establishment of the Central Bank 1961
The Central Bank of Iceland, Seðlabanki Íslands, was established by an Act of Parliament in April 1961. It is a state-owned institution administered by a Board of Governors consisting of three members appointed by the Prime Minister (according to an Act from 2001). There is also a seven-member Supervisory Board, elected by the Alþingi (Parliament), which acts in a supervisory and advisory capacity.

The Central Bank was assigned most of the traditional central banking functions, including the sole right to issue notes and coins and manage the foreign exchange reserves. The Central Bank acts as banker to the government and was for a period allowed to grant short-term credit to the Treasury. It was also given powers to regulate interest rates and also to influence the liquidity of the banking system both through short-term lending and by requiring the banks to hold blocked reserves with the Central Bank. Supervision of the operations of all institutions authorized to accept deposits from the public was also put in the hands of the Central Bank.

Although formally independent, the Central Bank was required by law to support the economic policy of the government. This was interpreted as meaning that the Bank could not make major changes in, for example, interest rates or reserve requirements, if these were objected to by the government. During the sixties no severe problems arose in policy coordination between the Bank and the government. This changed after inflation accelerated in the seventies, particularly following the oil crises, and monetary policy came under increasing strain. Interest rates, through government policy, were kept relatively low in spite of accelerating inflation, leading to strict rationing of credit and the erosion of monetary savings.

New role in deregulated finance market 1984
A radical change in monetary policy did not take place until after 1984 when the first steps were taken to deregulate interest rates. Two years later, in 1986, the Central Bank Act was revised, abolishing the Bank's powers to regulate the interest rates of commercial banks and savings banks. This quickly led to greater competition in financial markets and initially to rising interest rates. After these changes it became a priority task of the Central Bank to encourage the development of active markets in bonds and short-term government paper. An important step in that process was an agreement between the Bank and the Treasury limiting government access to credit from the Central Bank. Instead, the Treasury started selling both Treasury bills and bonds at regular auctions, laying the foundation for more effective money markets and market-determined interest rates.

The 1986 Act also strengthened the position of the Bank Inspectorate of the Central Bank, a supervisory department which was also given responsibility for the supervision of non-bank financial institutions.

Various changes took place during the last decades of the twentieth century. New markets were introduced and the Central Bank either took the initiative or participated actively in making these markets, among others the Iceland Stock Exchange, markets for long- and short-term paper and the currency market. Currency movements were liberalized. In 1999 the banking supervision was moved to a new Institution, the Financial Supervisory Authority (FME).

New Central Bank Act 2001
In May 2001, a new Act on the Central Bank of Iceland entered into force. The main elements of the new Act are as follows:

The main objective of monetary policy is to maintain price stability. With the approval of the Prime Minister, the Bank is authorised to adopt an inflation target as a framework for the conduct of monetary policy. An inflation target had been adopted on March 27, 2001 through a joint declaration of the Government and the Central Bank. By law, the Bank shall also promote other objectives, such as an efficient and safe financial system, including payments systems, and other tasks consistent with its role as a central bank. The Bank shall support the economic policy of the Government as long as it does not deem it inconsistent with the objective of price stability. The Act thus gives instrument independence to the Central Bank. The de facto ban on credit to the public sector that has been in force since the early 1990's becomes law with the new Act. Exchange rate policy is decided by the Central Bank, subject to the approval of the Prime Minister, but it has to be consistent with the main monetary policy objective of price stability. A lender of last resort function is provided for.

Accountability and independence
Monetary policy decision-making authority is vested in a Board of three Governors. They shall be appointed by the Prime Minister for seven-year terms with possible reappointment for a second seven year-term. The Minister specifically appoints the Chairman of the Board, also for a seven-year term with the possibility of one reappointment.

In order to ensure the highest degree of professionalism in the shaping and implementation of monetary policy, the Act instructs the Governors to set internal working rules on the preparations of, arguments for and presentation of monetary policy decisions. The rules shall, inter alias, cover the internal procedures to be followed, what information and indicators shall be primarily relied on and which staff shall participate in the process, although ultimately the decision-making authority rests with the three Governors.

The role of the Supervisory Board is spelled out more clearly than before and its membership was expanded to seven. It supervises the activities of the Bank and must approve various rules which are issued by the Governors, including those on the internal working procedures described above. The Supervisory Board also has to approve the operating budget for the Bank at the beginning of each year.

The Bank was relieved of expenditure obligations which more appropriately belong in the fiscal budget.

The Act provides for a buildup of the Bank's capital and reserves. When they are below a certain level defined in the bill, the Bank shall pay a third of its annual profit to the Treasury. Once they have reached the stipulated level, two-thirds of the profit shall be paid to the Treasury.

In sum, the Bank was granted instrument independence, its financial independence is better ensured and the legal demands on transparency and accountability are strengthened.

The new Act is explained further in Monetary Bulletin 2001/3.

In February 2009, the Act on the Central Bank was further amended. The main changes were that one Governor (and one Vice Governor) was appointed instead of three and that a Monetary Policy Committee, consisting of five members makes the decision on policy interest rates.

Objectives and roles
The Central Bank's main objective is to promote price stability. With the approval of the Minister of Finance and Economic Affairs, the Central Bank specifies a numerical inflation target. Furthermore, the Central Bank undertakes standard central banking tasks such as maintaining external reserves and promoting an efficient and safe financial system, including payment systems domestically and with foreign countries. The Central Bank of Iceland has the sole right to issue bank notes and to mint and issue coins or other currency which may circulate in place of banks notes or lawful coins.

The Central Bank of Iceland accepts deposits from deposit institutions, which consist of commercial banks, savings banks, branches of foreign deposit institutions and other institutions and companies authorized by law to accept deposits from the public for safekeeping and investment.

Main roles of the Central Bank of Iceland:

• To promote price stability;
• To promote financial stability;
• To issue notes and coin;
• To handle exchange rate matters;
• To act as banker to the Treasury and credit institutions;
• To maintain and invest Iceland's foreign reserve;
• To handle borrowing by the Republic of Iceland;
• To compile economic and monetary data, provide opinions and advise the Government on all foreign exchange and monetary issues.

Monetary policy
According to the Act no. 5/2009 amending the Act on the Central Bank of Iceland, no. 36/2001, decisions on applying the Central Bank’s monetary policy control mechanisms shall be taken by the Monetary Policy Committee. The control mechanisms include decisions on interest rates, part of transactions with credit institutions, decision on reserve requirements and currency market transactions. Decisions by the Monetary Policy Committee must be based on the Bank’s objectives and a thorough assessment of the current situation of and outlook for the economy and monetary issues and financial stability.

International cooperation
The Central Bank of Iceland has extensive responsibilities and obligations in the field of international finance. The Bank cooperates closely with other central banks and international economic and monetary organisations

International Monetary Fund The Central Bank represents Iceland at the International Monetary Fund (IMF). Iceland cooperates with the Nordic and Baltic countries through the Nordic-Baltic Constituency at the IMF, and they jointly elect an Executive Director as one of the Fund's 24 Executive Board members. Meetings of the IMF’s Board of Governors and Monetary and Financial Committee (IMFC) are held in Washington, the spring meetings usually in April and the Annual Meeting in September or October. In connection with the meetings, the Central Bank of Iceland publishes on its website the Nordic-Baltic Constituency Office’s reports to the IMF on the main activities of the Fund and its Executive Board. The joint Nordic-Baltic speeches presented to the IMFC and the IMF Annual Meeting are also published.

The Bank for International Settlements (BIS) The Central Bank is a shareholder in the Bank for International Settlements (BIS) in Basel, Switzerland, which is an important consultative forum for central banks, as well as an information and research institution in the field of monetary policy and financial stability. The Governor and other Central Bank staff members participate regularly in work carried out by the BIS.

Organisation for Economic Co-operation and Development (OECD) Central Bank representatives participate in the work of various OECD committees and groups, including the Economic Policy Committee, Working Party 1, the Committee on Financial Markets, and an expert committee on government debt management. OECD experts come to Iceland on a regular basis to keep abreast of economic developments, and they issue frequent reports setting forth the Organisation’s opinion of economic affairs in the country.

Co-operation with other central banks Central Bank of Iceland engages in a variety of tasks in co-operation with other central banks. The central banks in the Nordic region have long enjoyed close collaboration. The Bank also works regularly with the European Central Bank and, increasingly, with other central banks in Europe.

Other financial institutions The Central Bank cooperates with a large number of foreign financial institutions in connection with the management of its foreign exchange reserves, Treasury foreign debt, and other topics related to its operations.

Foreign exchange
Foreign exchange transactions have been subject to capital controls ever since the banking system collapsed in the autumn of 2008. Before the capital controls took effect, the Central Bank issued guidelines instructing the banks to limit foreign currency sales to essential transactions involving trade in goods and services. On 28 November 2008, the Rules on Foreign Exchange were adopted in accordance with temporary provisions in the Foreign Exchange Act. When the Rules took effect, all controls on current account foreign exchange transactions were lifted, but more stringent controls on cross‐border movement of capital and related foreign exchange transactions were imposed. The Rules have been reviewed and amended several times. The amendments have aimed primarily at closing loopholes in the original Rules.

The Central Bank of Iceland's report from 25 March 2011 contains a new strategy for liberalization of capital controls. The experience with the previous strategy is discussed, the development of the various conditions for lifting capital controls are described, the two main phases of the strategy are explained in broad terms, and the individual steps of the first phase are outlined in some detail.

Useful links

Currency of Iceland:

Iceland krona

List of Central Banks:

Central Banks

Official website of Central Bank of Iceland:

www.cb.is

Icelandic Ministry of Finance:

eng.fjarmalaraduneyti.is

Exchange rate:

www.cb.is