The financial crisis had serious consequences for the Icelandic economy. The national currency fell sharply in value, foreign currency transactions were virtually suspended for weeks, and the market capitalisation of the Icelandic stock exchange dropped by more than 90%. As a result of the crisis, Iceland underwent a severe economic recession; the nation's gross domestic product (GDP) dropped by 5.5% in real terms in the first six months of 2010. The Icelandic króna had declined more than 35% against the euro from January to September 2008. Inflation of consumer prices was running at 14% and Iceland's interest rates had been raised to 15.5% to deal with the high inflation. Unemployment had more than tripled by late November 2008.
Coming from a small domestic market, Iceland's banks have financed their expansion with loans on the interbank lending market and, more recently, by deposits from outside Iceland (which are also a form of external debt). Households also took on a large amount of debt, equivalent to 213% of disposable income, which led to inflation. This inflation was exacerbated by the practice of the Central Bank of Iceland issuing liquidity loans to banks on the basis of newly-issued, uncovered bonds – effectively, printing money on demand.
In 2001, banks were deregulated in Iceland. The crisis unfolded when banks became unable to refinance their debts. It is estimated that the three major banks held foreign debt in excess of €50 billion, or about €160,000 per Icelandic resident, compared with Iceland's gross domestic product