Crisis deepens for Iceland as last of 'big three' banks is nationalised

The financial crisis in Iceland shows no sign of easing, with the government forced to announce the nationalisation of the country's largest bank yesterday. After taking control of Kaupthing, the Icelandic authorities were also forced to suspend dealing in all 15 companies listed on the country's stock exchange until Monday.

The collapse of Kaupthing, the last of the trio of large Icelandic banks brought low by the credit crisis, prompted an escalation of the row brewing between the north Atlantic island and the UK. Sigurdur Einarsson, the bank's chairman, said Kaupthing had had no choice but to accept state protection after the British Government took control of its UK subsidiaries.

Mr Einarsson said: "After the British Chancellor of the Exchequer stated that Iceland did not intend to honour its obligations to British depositors, the Financial Services Authority in the UK transferred Kaupthing Edge from the bank's subsidiary Kaupthing Singer & Friedlander. Kaupthing Singer & Friedlander was subsequently placed into administration and Kaupthing Bank's creditors pointed out that this situation represented an event of default according to the company's loan agreements and was therefore a technical default. It did not matter that the parent company had sufficient liquidity and its position was solid."

The nationalisation will not affect its customers in the UK in the same way as savers with Icesave, the British arm of the now nationalised Landsbanki. Alistair Darling, the Chancellor, signed off a deal earlier this week transferring the British business to ING, the Dutch banking giant, which has already taken over responsibility for 160,000 UK savers with £2.5bn of deposits. However, any savers who invested in Landsbanki's Guernsey subsidiary are not covered by either the UK or Icelandic deposit insurance schemes and will have to wait to see what assets the administrator, Deloitte, can recover.

In addition to Kaupthing and Landsbanki, a third Icelandic bank, Glitnir, has also collapsed, with the crisis threatening to bankrupt the country as a whole. Iceland's banks had assets worth nine times the country's total GDP.

The International Monetary Fund said yesterday that it would consider coming to Iceland's assistance. However, Geir Haarde, the Icelandic prime minister, said the country still had other options than turning to the IMF .

Icelandic officials plan to begin negotiations with Russia next week over a €4bn loan facility, and the country has some credit lines in place from other Nordic countries, though Mr Haarde described this as "absolutely a last resort type of arrangement". He added that while the government had taken control of the biggest banks, it had not taken on their assets or obligations. That is likely to anger British officials, with Mr Darling already having complained that the Treasury has found it very difficult to get information from Reykjavik.

The remarks may also be a reaction to the threat by Gordon Brown to sue Iceland over the £3.5bn of deposits held by British savers in Icesave, which the UK Government has now felt compelled to promise to guarantee.

However, the ratings agency Fitch said the country would find it difficult to distance itself from its banking industry and downgraded its rating of the country's financial position. "Iceland faces a very severe recession which will result in a further deterioration in banks' domestic assets," Fitch said.

Economists expect the country's economy to shrink at least 10 per cent.