WORRIES over the state of Iceland’s economy have been building for some time but they have never seemed as justified as they have been in the past few days.

The week got off to an awful start when on Monday the Reykjavik government stepped in to save Glitnir, the third-largest bank, after it ran into funding difficulties.

The government spent €600m (£467m) for a 75% stake, which wiped out the bank’s largest shareholder, the investment company Stodir, which owned 32% of the shares. As a result, Stodir was forced to apply for administration.

Given that Stodir is an investment vehicle of Jon Asgeir Johannesson, the tycoon behind the Baugur retail empire, questions were asked about the potential knock-on effects.

One person who knows Johannesson well described the bank nationalisation as “an extremely dramatic step that went beyond what was required”.

The government’s move prompted ratings agencies, including Standard & Poor’s, Fitch and Moody’s, to downgrade their stance on the country’s banks and the sovereign debt.

The currency, the krona, fell to record lows against the euro, while the cost of protecting the country’s sovereign debt against default rose strongly last week.

The country’s two largest banks also took steps to shore up confidence in their businesses. Landsbanki, the second-largest lender, sold its overseas corporate-finance assets, including British stockbrokers Teather & Greenwood and Bridgewell, to the fourth-largest bank, Straumur. It intends to return to a more traditional role as a plain-vanilla commercial and retail lender.

On Friday there were more jitters after it emerged that Kaupthing had been closing down some of its clients’ positions in contracts for difference, (CDFs), a financial product that allows investors to take highly leveraged positions by putting up as little as 10% of the value of their holding in a stock.

A Kaupthing spokesman explained that the move to close some accounts was a “sensible” ploy that was aimed at cutting the bank’s leveraging.

The banks’ problems have stemmed from an over-reliance on wholesale markets for their funding rather than retail deposits, something that Landsbanki and Kaupthing have been addressing over the past two years. Their respective ratio of deposits to loans is 63% and 50% — hardly reassuringly conservative but considerably healthier than they had been.

“Both Kaupthing and Landsbanki have benefited from their deposit bases,” wrote Richard Thomas, an analyst at Merrill Lynch, in a note published last week. “Having these deposit bases has been key to the banks’ resilience in exceptionally tough market conditions.”

It remains to be seen whether they will be resilient enough.

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