RTTNews - Iceland's recession is likely to be deeper this year than in most developed economies, the Organization for Economic Co-operation and Development or OECD said Wednesday.

In its economic survey of Iceland, the Paris-based think tank forecast Iceland's economy to contract around 7% this year followed by a gradual recovery next year.

Iceland has plunged into its deepest economic recession in decades after succumbing to a widespread financing crisis and a collapse of domestic demand, the OECD said.

The unemployment rate is projected to rise to a peak of 10% in 2010 while inflation should fall to around 2.5%.

It said the economic situation in Iceland also turned for the worse when the country's three main banks, Glitnir, Kaupthing and Landsbanki, collapsed in October last year. In addition, capital markets seized up and financial relations with foreign countries were shut down.

Iceland's government rescued these three banks, which represents 85% of the country's banking system. Later, the Icelandic authorities created three new banks, Islandsbanki, New Kaupthing and New Landsbanki, by transferring all domestic deposits previously held by the old banks.

But, the OECD warned that there is still a need to rethink the regulatory and supervisory framework. It also said bank supervisors need to lay down tougher rules and apply them more strictly.

In the future, Iceland's supervisors should not allow the banking sector to become so complex and so large that they cannot effectively fulfill their supervisory duties. Also, bank supervisors should lay down tougher rules and, subsequently, apply stricter practice on large exposures, connected lending and quality of owners, using discretionary best judgment when necessary.

Moreover, the OECD said if Iceland were to become an EU member, it should seek entry into the euro area as soon as possible, so as to reap the economic benefits. In July, Iceland had applied for EU entry.

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