Iceland scales back on trading in currency derivatives

COPENHAGEN (Reuters) - Iceland's central bank said on Monday it would scale back some exemptions to its Foreign Exchange Act for derivatives trading, stepping up efforts to stabilize its krona currency.

The bank said it would trim exemptions granted earlier in the year relating to derivatives trading with domestic financial institutions for hedging purposes, making it harder for foreign investors to bet on the krona.

In March, Iceland lifted most of the remaining capital controls imposed at the height of the financial crisis in 2008 when the Nordic country's banking system collapsed and the krona plunged.

Those exemptions made it possible to conduct carry trades by issuing so-called Glacier bonds in Icelandic krona and enter derivatives contracts with domestic banks.

The bank said it was seeking to avoid an accumulation of foreigners' short-term krona positions that could raise macroeconomic and financial risks.

"Experience has shown that capital inflows in connection with foreign issuance of krona-denominated bonds (Glacier bonds) could weaken monetary policy," it said in a statement.

"(This) could contribute to exchange rate volatility and trigger unsustainable credit growth and asset price increases."

Capital controls left Iceland isolated from international financial markets and have hampered recovery.

(Reporting by Jacob Gronholt-Pedersen; editing by Mark Heinrich)

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