REYKJAVIK, Iceland - Iceland's government took control of the country's largest bank Thursday as it struggled to prevent an all-out collapse in its overweight banking system.
The decision to take over Kaupthing means that all three of Iceland's major banks are under the protective wing of the tiny Nordic nation's Financial Supervisory Authority.
The authority said the action was necessary to ensure the "continued orderly operation of domestic banking and the safety of domestic deposits." Kaupthing would be open for business as usual on Thursday and the bank's domestic deposits are guaranteed under Icelandic law, it added.
The government has already seized the controls of Landsbanki and Glitnir banks — which are both now in receivership — after Prime Minister Geir H. Haarde warned that the country was at risk of "national bankruptcy."
The three banks are being blamed for the financial catastrophe facing Iceland.
A stock market boom in the mid-1990s supported the rapid growth of the country's banking sector, which now dwarfs the rest of the economy with assets at nine times annual gross domestic product of $19 billion.
The newly wealthy banking sector provided financing for a number of business deals across Europe — Kaupthing alone has racked up debts of more than $5.25 billion in five years to help fund British deals.
When liquidity markets dried up around the world, they struggled to refinance those heavy debts.
Haarde said on Wednesday that the banking sector had "become too big" as he acknowledged that it will take the nation of just 320,000 people several years to recover from the crisis.
Iceland's troubles have caused ripples across Europe, where many people have accounts in subsidiaries of the three banks.
Glitnir, the country's third largest bank, said on Thursday that it had received liquidity support from the Norwegian Banks' Guarantee Fund of $820,000 for its Norwegian unit. The sale of the unit had begun, it added.
Glitnir said it had approached the Norwegian Financial Supervisory Authority for help and that the result was a "good solution for our customers, our employees and the Norwegian financial market."
Glitnir's move into receivership on Wednesday was a sign that troubles at the bank were larger than the government thought when it announced less than two weeks ago that it would nationalize the bank — the switch into receivership gives Glitnir temporary protection from its debt obligations.
In urgent moves to downsize the overgrown banking sector, the Financial Services Authority immediately began to restructure the bank, saying it would sell its Finnish and Swedish businesses.
Similarly, Iceland's central bank had already loaned $680 million to Kaupthing earlier this week while the Swedish central bank had provided a loan of up to $702 million.
Those measures proved not to be enough in a rapidly deteriorating situation.
In Britain, savings bank ING Direct UK has already agreed to buy more than 3 billion pounds $5.3 billion of deposits held by around 180,000 British savers with Kaupthing Edge and Heritable Bank, which is owned by Landsbanki.
The collapse of Landsbanki led to a diplomatic spat between Britain and Iceland over the standing of accounts held by British customers of the bank's Online arm, IceSave.
After British Prime Minister Gordon Brown said he would pursue legal action to recover the lost deposits of some 300,000 Britons who hold accounts with IceSave, Haarde said that discussions had begun between the two countries to find a "mutually satisfactory solution."