The EFTA (European Free Trade Association) court on Monday ruled that the government of Iceland had not breached the deposit guarantee directive for savers in the collapsed Icesave bank.
Reykjavik had been charged with failing to guarantee minimum levels of compensation to UK and Dutch savers, who were bailed out by their own governments.
Icesave, an online savings bank, was a victim of the 2008 collapse of Iceland’s banking system.
"Iceland has from the start maintained that there is legal uncertainty as to whether a state is responsible for ensuring payments of minimum guarantees to depositors using its own funds and has stressed the importance of having this issue clarified in court," the Icelandic government told the BBC.
When Iceland’s banks were in crisis, UK Chancellor Alistair Darling bailed out 230,000 UK savers in Icesave to the full extent of their savings - about £3.5bn. This was more than the maximum decreed by European rules for deposit compensation schemes.
The EFTA judgment said, "the Court holds that the Directive does not envisage that the defendant itself must ensure payments to depositors in the Icesave branches in the Netherlands and the United Kingdom, in accordance with Articles 7 and 10 of the Directive, in a systemic crisis of the magnitude experienced in Iceland."
The Icelandic government originally agreed to re compensate its European neighbours in 2009 but the move was very unpopular. Icelandic people complained that the payouts would bankrupt them and that the UK and Dutch governments had compensated their citizens a much greater amount than required by European legislation.
The president of Iceland refused the deal and a referendum was held in March 2010, in which the Icelandic population strongly rejected the move.
A second referendum on a new deal on repayments also resulted in a “no” voter in April 2011, though by the much narrower margin of 59 per cent to 41 per cent.
Nonetheless, Iceland has in fact re payed the British and Dutch governments more than 90 percent of the minimum deposit guarantee the two governments were obliged to pay.
There are concerns that this ruling could undermine cross-border banking in the European Union. Some governments worry retail depositors could be left unprotected in the case of another banking collapse.
This risk appears to have been mitigated by a change in the law since the collapse of the Icelandic banks. Whereas before there was no minimum requirement for EU banks to protect deposits of their savers, at the moment each EU member state must insure they have coverage of up to €100,000 for every depositor.