Image: Kaupthing Bank
Bob Strong  /  Reuters
A man walks past a branch of Iceland’s Kaupthing Bank in Reykjavik Thursday. Iceland took control of its biggest bank to try to shore up the nation’s teetering banking system.
updated 10/9/2008 8:46:16 AM ET 2008-10-09T12:46:16

Iceland suspended trading on its stock exchange for two days and took control of the country's largest bank — the third to be placed under its protective umbrella — on Thursday as it grappled with a banking crisis that is threatening to engulf the entire country.

The Nordic nation's government also used sweeping new emergency powers to create a new bank that will take over the bulk of the domestic operations of another one of its collapsed banks.

The country is struggling to get a grip on the collapse of its top-heavy banking system, a situation that Prime Minister Geir H. Haarde has warned is putting Iceland at risk of "national bankruptcy."

Government officials announced that President Olafur Ragnar Grimsson was hospitalized Monday and Tuesday after undergoing coronary angioplasty and coronary dilation. Grimsson has been advised not to return to work for a a few days.

A stock market boom in the mid-1990s supported the rapid growth of Iceland's banking sector, which came to dwarf the rest of the economy and provided financing for deals that ranged across Europe and conquered swaths of the British economy, from fashion retailers to top soccer teams..

The strategy gave Iceland one of the world's highest per-capita incomes, but when liquidity markets dried up around the world, the banks struggled to refinance those heavy debts.

Now Icelanders are watching helplessly as their economy implodes, causing ripples throughout Europe, where tens of thousands of people have accounts with subsidiaries of the Icelandic banks..

The OMX Nordic Exchange Iceland said that equity trading would remain halted until Monday because of "unusual market conditions."

The government's decision to take control of Kaupthing, the country's leading bank, which has assets and debts across the continent, means that the Financial Services Authority now has control of all three of the country's major banks. The other two, Landsbanki and Glitnir, are in receivership.

The authority said the action was necessary to ensure the "continued orderly operation of domestic banking and the safety of domestic deposits."

It also used emergency powers, rushed in by parliament earlier this week, to hive off most of the domestic assets of Landsbanki into a separate entity to be called "New Landsbanki" that is fully owned by the government.

"The decision means that the new bank takes over all the bank's deposits in Iceland, and also the bulk of the banks assets that relate to its Icelandic operations, such as loans and other claims," it said in a statement.

"The decision ensures continued banking operations for Icelandic families and businesses," it added.

In an attempt to curb any panic, the regulator stressed that both Kaupthing and Landsbanki were open for business as usual on Thursday and that all domestic deposits of the bank were guaranteed under Icelandic law. However, the move leaves the international operations of Landsbanki, which have already caused a diplomatic spat with Britain, open to question.

British Prime Minister Gordon Brown has threatened to sue Iceland to recover the lost deposits of some 300,000 Britons who hold accounts with IceSave, the online arm of Landsbanki.

With local governments also holding accounts worth tens of millions of pounds in Icelandic banks, the British government has also used powers under terrorism laws to freeze Landsbanki's assets until the status of the deposits is resolved.

Savings bank ING Direct UK has 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.

Haarde said on Wednesday that discussions between the two countries had begun between the two countries to find a "mutually satisfactory solution."

Iceland's three major banks are being blamed for the financial catastrophe facing the country. 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 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 tiny Nordic nation of just 320,000 people several years to recover from the current crisis.

Glitnir, the country's third largest bank, said on Thursday that it had received liquidity support from the Norwegian Banks' Guarantee Fund of 5 billion Norwegian crowns ($820,000) for its Norwegian unit. It added that the sale of the unit had begun.

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 500 million euros ($680 million) to Kaupthing earlier this week while the Swedish central bank had provided a loan of up to 5 billion crowns ($702 million).

Those measures proved not to be enough in a rapidly deteriorating situation.

© 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

Video: Iceland bracing for 'severe recession'

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