Lánasjóður sveitarfélaga - Municipality Credit Iceland (MCI), first established in 1967, is a limited liability company owned by all Icelandic municipalities.

With an Act on MCI, effective as of January 1st 2005, the responsibility for the operation of MCI was transferred from the Ministry of Social Affairs directly to the municipalities. In this relation, the municipalities formulated a new strategy for MCI, proposing a more active role for its financing of the municipal borrowing needs and, consequently, increased borrowing activity of MCI.

As of January 1st 2007 MCI was incorporated as a statutory limited liability company. The share capital of MCI is ISK5 billion. Before the incorporation the capital of MCI was reduced by ISK3 billion, the amount to be distributed to the municipalities in the years 2007-2010. Mid year 2009, MCI had equity of ISK 11.859 million.

Its Nordic peers include Kommunalbanken, Norway; Kommuninvest i Sverige, Sweden; KommuneKredit, Denmark; and, Municipality Finance Plc, Finland.

Pursuant to the new Acts, MCI became a fully-fledged financial institution and is, as such, supervised by the Icelandic Financial Supervisor (FME) and bound by the regulations of the Central Bank of Iceland, regarding capital adequacy ratio, large exposures, market risks, minimum reserve requirements, liquidity ratio and other relevant stipulations.  For capital adequacy purposes, loans to Icelandic municipalities carry a 20% risk-weighting.

Its objective is to secure loans on favourable terms to Icelandic municipalities, their institutions and enterprises for projects of general public interest [1]. The supreme authority at MCI rests with the Annual General Meetings. These meetings are attended by representatives appointed by the municipalities. The AGM elects a Board of 5 members, approves the accounts and selects the auditors, among other things. MCI is managed by the Managing Director.

MCI is based in Reykjavik, at the same premises as the Association of Local Authorities in Iceland. 

Operations and Funding
At year end 2008 MCI provided 21% of Icelandic municipalities’ financing needs, up from 18% in 2006 and 10% in 2004. MCI’s five-year plan should allow it to increase its market share to 25-30% of municipal financing needs. 

MCI’s activities, reflecting the areas of Icelandic municipal responsibilities, include lending principally for projects in education (kindergartens, primary and lower secondary schools including sport facilities), geothermal heating, followed by financing of capital investment projects for roads, sewerage, harbours, recreation, solid waste and wastewater treatment and disposal.
Until 2005 MCI still granted loans predominantly against its capital. However, its borrowing activity has increased since 2003, the first year it started issuing bonds on the domestic market.  At the end of 2008 borrowing had increased significantly compeared with 2006.  Due to its limited size, MCI has so far not borrowed at the international capital markets, hence has not applied for a formal rating as of yet.  Foreign funding has been limited to loans from financial institutions on a bilateral basis. As of October 2008 MCI has increased its bond issuing in the local market considerably.

As for the process for granting loans, municipalities apply to MCI, whether for a new project or for refinancing of some of the higher interest-rate investment loans.  MCI then makes the assessment of the financial position of the applying municipality in accordance with the loan rules set by the board. MCI maintains the same loan conditions for all its borrowers.  MCI has suffered no loan losses since its inception in 1967.

Security
Unlike some of its Nordic peers, MCI does not benefit from joint and several guarantees of its municipal owners.  However, MCI does benefit from asset guarantees given a collateral system in place.

Article 73 of the Local Government Act no. 45/1998 stipulates that a municipality may put up its revenues (such as contributions from the Local Authorities´ Equalisation Fund and income tax revenue) as security for loans it receives from MCI and for guarantees it provides in favour of the MCI’s borrowers[2].  In other words, should a municipality default on its loan obligation to MCI, the equalisation transfer or income tax transfer would, instead of being paid out by the Ministry of Social Affairs or by the State Treasury in case of income tax to the municipality, go directly to MCI. When granting loans, MCI requires in all cases that such security be provided by all borrowing municipalities, except where Reykjavik City is a borrower or guarantor.

MCI value added
MCI’s competitiveness stems from the low margins it charges and its lower cost of funding in the market. Only a few larger municipalities have the capacity to access the domestic capital market or borrow in foreign currency, often managing this activity and the resulting foreign exposure through banks.  For loans financed with borrowed funds, a modest margin is charged to cover costs.

MCI’s added value therefore underlies in the fact that it can help smaller, and financially weaker, Icelandic municipalities to have access to domestic and international capital markets in the financing of their social infrastructure investments, thereby decreasing their cost of funds. This should also contribute to reducing regional imbalances throughout the country.

The most important points regarding MCI’s financial fundamentals are presented in the table below:

Key financial figures 2007 and 2008

(* CAD ratio in annual report 2007 is calculated useing Basel I)

Icelandic public sector is a two-tier system consisting of the central government and, currently, 77 municipalities (down from 225 municipalities 15 years ago, although there should still be space for further consolidation due to their small average size, with 75% having less than a thousand inhabitants).  The greater Reykjavik area, including Reykjavik City and 6 surrounding municipalities, concentrates around 60% of the total population of 320.000 inhabitants, while the second largest town Akureyri only accounts for around 9% of total population. 

Icelandic municipalities are responsible for around 35% of all public spending.  Reflecting State policy of strengthening Icelandic local government and consequent transferring of new responsibilities to the municipal level, local government budgets have grown from an average of 7% of GDP in the early eighties to around 13% of GDP today.  The specific rules regarding self-government have been laid down in a Local Government Act no. 45/1998 and the Constitution.

Since 1996, local authorities in Iceland have assumed full responsibility for all primary and lower secondary school functions (for pupils from 6 to 15 years of age).  Consequently, education represents the largest expenditure item, ranging anywhere from 35% to 70% of municipal expenditures.  This is followed by expenditure on various welfare services (in particular as regards the services for the elderly except for healthcare), culture and recreation and road works and traffic.  Local governments are also responsible for local planning and most local infrastructure.  They also take responsibility for solving the housing needs of low-income households and provide supplementary assistance to general programmes of pensions otherwise run by the central government.  Some big ticket items such as healthcare and social security, however, remain direct responsibility of the central government.

These responsibilities are financed from a number of sources, although tax dependency is rather strong.  On average, 60% of local government revenues come from municipal income taxes, followed by proceeds from real estate taxes and other indirect taxes (around 15% of total revenues).  Local governments also operate municipal companies which render services to the general public for a fee (an additional 10% of revenues).  Geothermal power companies are often in municipal ownership and local governments are still active in electricity production capacity in Iceland through ownership in local electricity distribution.  Many also own operating companies for the harbours.  The general policy is to fix the tariffs at a level which ensures financial autonomy of these companies, independent from local government direct financial assistance.  According to the aggregate statistics, government-financed Local Authorities´ Equalisation Fund transfers represent an additional 10% of local government receipts, underlining a more fragile position of smaller municipalities.

The finances of local governments in Iceland have improved in the last few years, reverting back to a surplus position.  In the period of 1990-2000, however, local governments ran deficits averaging 5.5%, and reaching 18% at the bottom of the recession in 1992-95.  Main reasons for such deficits had to do with the pressure on local authorities to stimulate job creation during economic downturns in the early nineties as well as, more recently, assumption of responsibility for primary education and, in particular, a change to one shift schooling which had proved very expensive.  In spite of persistent deficits, gross local government debt has hovered around 7% of GDP up to 2000, and actually fell to around 4% in 2003 due to stepped-up asset sales, economic growth and a 10% strengthening of the Icelandic króna (ISK) in 2002.  It is also of note that discretionary factor in local budgets is considerably larger than that of the central government.  In particular, fixed investment has typically accounted for 15-20% of local government budgets compared to 5-7% for central government.

According to the Local Government Act, the Ministry of Social Affairs is in charge of municipal matters; in case of financial difficulties, the municipalities can cut discretionary expenditures, increase taxation (up to the maximum set by the State) or speed-up property sales.  In case of serious or long-lasting financial crisis, the municipality may be deprived of some degree of autonomy (on the proposal of a monitoring committee, the municipal council’s fiscal powers over a municipality can be suspended by the Minister of Social Affairs and a financial management board be appointed).  Importantly, however, should a municipality find itself in financial difficulties, such that it cannot meet the expenses of its mandatory tasks or other obligations, the Ministry of Social Affairs may provide the municipality a grant or loan from the Local Authorities’ Equalisation Fund, in order to rectify the finances of the municipality, on conditions laid down by the Ministry.  All Icelandic municipalities belong to the Equalisation Fund.

Compared to other Nordic countries, Iceland’s local authorities’ share in public spending is relatively small because the State takes responsibility for many of the costly functions handled by local or regional authorities in other Nordic countries. The larger role played by the central government in Iceland can be attributed to the size and disparate territorial distribution of the population.

Please note, however, that the same law stipulates that those assets of a municipality which are necessary in order for it to perform its mandatory tasks are not subject to attachment for debt, and that municipalities can not be subject to insolvency proceedings.