Iceland to investigate suspected market manipulation

STOCKHOLM, March 31 (Reuters) - Iceland's financial watchdog said on Monday it had begun investigating whether market players may have deliberately spread rumours about alleged weakness in the island's banks to manipulate the market.

Iceland's banks have been frozen out of credit markets in the last few months over fears they could default on debt, while the country's currency has been battered by worries the economy is headed for a sharp slowdown after years of red-hot growth.

"Last week we started to gather information on whether negative rumours had systematically been spread against the Icelandic banks and the Icelandic financial system in order for those spreading the rumours to profit from it," the head of Iceland's Financial Services Authority said by phone from Reykjavik.

Jonas Jonsson, director general of the FSA, declined to comment on who had been contacted or the scope of the probe.

"We considered at least there is a reason to investigate it. Steps will be decided on with regard to the information we get," he said.

Iceland's three main banks, Kaupthing (KAUP.IC: Quote, Profile, Research, Stock Buzz), Landsbanki (LAIS.IC: Quote, Profile, Research, Stock Buzz) and Glitnir (GLB.IC: Quote, Profile, Research, Stock Buzz), have been rocked by speculation about their ability to handle the debts they have built up as they expanded overseas in recent years.

The banks themselves have continually stressed they have ample liquidity and well-diversified income streams.

But the cost of insuring their debt against default has soared, effectively freezing them out of credit markets.

Five-year credit default swap spreads on Kaupthing and Glitnir exceeded 1,000 basis points on Monday, higher than Bear Stearns BSC.N before its bailout and sale to JPMorgan (JPM.N: Quote, Profile, Research, Stock Buzz).