Exchange rate indexation of loans is illegal in Iceland and this also applies to domestic loans, according to a new court ruling that could have major consequences.

Exchange rate indexation of loans means that the total amount owed in Icelandic kronur varies according to its exchange rate against the currencies in which the loan was issued. Such loans were aggressively promoted by the Icelandic banks in previous years and have now left many diligent car and home owners with bigger debts than the original amount – despite paying their bills every month.

Now the Reykjavik District Court has ruled that such loans are illegal – a ruling which directly contradicts a ruling in the same court in December, RUV reported.

According to the legal precedent, courts may now start ordering that exchange rate indexed loans be turned into regular inflation indexed loans denominated in Icelandic kronur.

The whole issue rests on a slight loophole, as exchange rate indexation is indeed illegal; but it is not illegal to lend in foreign currencies and then secure repayments in those currencies or in Icelandic kronur. But it is illegal to lend in Icelandic kronur and secure repayments pegged to the exchange rate of foreign currencies.

Customers taking out ‘foreign currency loans’ in Icelandic banks to buy homes and cars in Iceland were given their money in Icelandic kronur. The court has now ruled that this was illegal.