Impact of Acquis on Monetary Policy and Functions of the Central Bank

1. Impact of Acquis on Monetary Policy and Functions of the Central Bank

2. Overview • Statistical work and data reporting • Market operations • International Cooperation • Conduct of Monetary Policy • Payment systems and accounting • Coins and note issuance

3. General observation • There seem to be no serious conflicts between existing Icelandic legislation and EU law relevant for chapter 17. Icelandic law is more or less compatible with the acquis. • Implementing the acquis nevertheless requires numerous changes in the law and adjustments in the regulatory framework. • The impact of legislative alignment would be more exact, disciplined and forward looking fiscal policies, more focused monetary policies, as well as higher standards of market operations and statistical and data management practices in the Central Bank of Iceland.

4. Statistical work and data reporting • Iceland Statistics participates in the European Statistical System on the basis of the EEA agreement. • The Central Bank needs to increase the frequency and detail of data reporting including: • Balance of Payments • Foreign and domestic debt • Market interest rates • Quarterly financial accounts • In line with the February 2010 Commission opinion on Ch. 18 it is necessary to establish a centralized securities data base to fulfill requirements for the security-by-security methodology. • Need to change the law to enable the CB to report directly to the ECB, e.g. the law does not distinguish between statistics used for surveillance and statistical purposes. • Need to synchronize CB/ECB legal basis for on site inspection and the use of sanctions

5. Market operations • CBI has similar reserve requirements as the ECB but the law will need to be changed regarding sanctions when reserve requirements are not fulfilled. The reserve ratio is now 2 percent but cannot be changed without changing the regulation, need more flexibility in reserve ratios which are now between 0%-10% in the ECB. • Adoption of the guidelines on monetary policy instruments and procedures of the Eurosystem require some legal changes and different practices at the CBI. • The same goes for guidelines on minimum standards when conducting monetary policy operations, foreign exchange operations with the ECB's foreign reserves and managing the ECB's foreign reserve assets • Changes will affect rules on e.g. insider trading, gifts to staff and prevention of conflict of interest

6. International cooperation • The Central Bank will participate in various committees and working groups including the Economic and Financial Committee, Economic Policy Committee, and Monetary Committee. • Successful participation in this work will require considerable resources in terms of manpower and preparations • Iceland has a long history of successful international cooperation and participation in international organizations, including NATO, UN IMF, EEA, WTO • Iceland as a small country must choose the most important committees and prevent overburdening the bureaucratic structure

7. Conduct of monetary policy • Price stability is already a primary objective of the CBI. • When entering the eurozone, the legal framework will be aligned as necessary. • Seeking an acceptable long term solution to the currency issue is one of the main objectives of Iceland’s application for EU membership. • Possible monetary policy options during pre-accession and post-accession are being investigated by the CBI.

8. Payment system and Accounting • In the Commission opinion on ch. 4 it is noted that all acquis related to payment systems have been adopted under the EEA agreement. Still considerable investment will be needed to introduce and adapt payment and accounting systems to EU standards. The CBI has now assumed the responsibility for the payment system. • The CB has already started preparatory work on Target2 Securities which is open for non-euro countries. However, this work will be on hold as T2S is incompatible with capital controls. • Participation in Target2 (after the euro is adopted) will enhance payment systems security and effectiveness and facilitate trade. • The CB is in the process of preparing for new accounting systems which would fulfill ECB requirements.

9. Coins and banknote issuance • The use of cash in Iceland is low by Western European standards. • For decades cash in circulation as a proportion of GDP remained close to 1%. It rose after the banking crisis in October 2008 and has been around 2% since then. • Most payments for goods and services are done by debit cards, credit cards, internet banking, etc. • Active online banking users equal the population of Iceland • 75% of financial transactions are executed through online banking • The number of debit and credit card transactions in Iceland are the highest in the world per capita • Counterfeiting of notes and coins is not a big problem in Iceland.

10. Exchange rate policy-stability and common interest • Copenhagen criteria fulfilled: • The Commission has carefully evaluated the Icelandic economy against the Copenhagen criteria • Iceland has a well-functioning market economy and a high level of competitiveness in main industries. • Able to take on the obligations of membership • Regaining macroeconomic and financial stability • Credible monetary framework • Institutional capacity to implement coherent policies • Iceland has no problem with the objective to minimize real exchange rate misalignment and avoid excessive nominal fluctuations (TFEU 142, ERM-II declaration, June 97) . • Pre-accession monetary and exchange rate framework will be changed to better enable coordination of economic policies. • The CBI has proposed more focus on exchange rate stability in the inflation targeting plus proposal.

11. Exchange rate policy-stability and common interest • Will enter the EMU as member with a derogation (Art. 139. TFEU) • Discussion on exchange rate policies is a priority and support for the currency should be obtained as soon as possible according the the majority view of the Foreign Affairs Parliamentary Committee • Fulfilling the Maastricht criteria should be a priority independent of EU membership • Likely to aim for ERM II as soon as conditions permit. • Capable to participate in the new surveillance procedures. • Access to balance of payments support is an important precautionary possibility. (Art. 143 TFEU)

12. Progress towards sustainable convergence • High degree of price stability(Art. 140 (1) TFEU • Inflation has come down rapidly in recent months. • Sustainable financial position of the government. • According to IMF and Icelandic government projections general government should be in surplus 2013. • Convergence of long-term interest rates. • Dependent on exchange rate stability and low inflation. • Macro stability. • Pension mostly fully funded, traditionally Iceland has had a low unemployment and we are now running a surplus on the trade balance.