Tue May 27, 2014 2:26pm EDT
* Claims against banks total $66 bln, assets $22 bln
* Paying out creditors would destabilise economy, krona
* Says creditors need to reduce expectations for payout
By Simon Johnson
STOCKHOLM, May 27 (Reuters) - Iceland's defunct banks could be put into bankruptcy if creditors do not agree to a haircut on debts owed by Kaupthing, Glitnir and Landsbanki, which collapsed in 2008 owing more than $75 billion, the finance minister warned on Tuesday.
Iceland slapped on capital controls after the financial meltdown, hampering much needed investment, but these cannot be removed until a deal to wind up the left-overs of the old banks - around 2,500 billion krona ($22 billion) in cash, shares and bonds - is reached with creditors.
"It should be obvious to everyone that winding up procedures can't take forever," Finance Minister Bjarni Benediktsson said in a telephone interview. "If they are unsuccessful, then we have to take it to the next step. That (bankruptcy) may well happen. One should not exclude that possibility if the winding up procedures that started in 2009 don't show any success."
Bankruptcy would mean a fire-sale of assets and probably much lower recoveries for creditors, who have claims against the old banks totalling 7,530 billion Iceland krona ($66 billion), dwarfing Iceland's 2013 GDP of 1,786 billion krona.
Benediktsson said plans put forward so far by the old banks for paying creditors did not go far enough to reduce the risk of destabilising the economy and the krona.
But he would not be drawn on how much of a haircut, creditors - such as Bayerische Landesbank and Deutsche Bank Trust Company Americas - would need to take.
"It has been evident and it has been clear for years that assets in the estates will not and cannot all exit (through) the FX market without severe effects on the exchange rate in Iceland," Benediktsson said.
"There is no logical reason why the central bank or the government would allow that to happen."
Creditors, however, have complained Iceland has not said what kind of deal it wants.
Kaupthing and Glitnir put forward plans to pay creditors in late 2012, but say they have yet to receive a formal response from the central bank, which, along with the Finance Ministry has to okay any deal.
In May, the estate of Landsbanki agreed a deal with its creditors to extend repayment of around 226 billion krona in bonds issued when the government took over the bank.
Benediktsson said this would reduce repayments by state-owned Landsbankinn - which took over Landsbanki's assets - over the next few years, a key step in removing capital controls.
But the terms of the deal - including exemptions from capital controls - needed to be considered carefully.
"We do not want to give a precedent that others cannot enjoy," he said. "They have given us three months to answer. We will just have to see what the answer will be."
While Iceland will not risk financial stability for a quick fix to the problem of the old banks, Benediktsson said capital controls could be removed relatively quickly, if a comprehensive agreement with creditors is reached.
"I don't think we need to drag out the capital controls for years and years," he said. "It is about aligning the expectations and up to now expectations on their behalf are not aligned to our ideas." ($1 = 113.6450 Iceland Kronas) (Reporting by Simon Johnson)
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