Iceland’s economic meltdown gathered pace yesterday as the state seized control of its biggest bank and suspended trading on its stock exchange.

With the nationalisation of Kaupthing, the Icelandic Government has now taken control of all three of the country’s big banks – Kaupthing, Landsbanki and Glitnir – as it struggles keep a lid on the panic.

The OMX Nordic Exchange Iceland said yesterday that it would not reopen until Monday because of the unusual market conditions.

The move came after British authorities seized control of Kaupthing Singer & Friedlander (KSF), the UK arm of Kaupthing, which employs almost 700 people in the City, appointing Ernst & Young as administrator. The Times has established that on Wednesday the British Government paid out £2.5 billion to underwrite the risks associated with 160,000 individual depositors in KSF.

Under a deal agreed with ING Direct, the Dutch retail bank, the Treasury stepped in to underwrite the depositors, who had accounts with Kaupthing Edge, the internet division.

It is understood that, eventually, the majority of the £2.5 billion will be financed by the Financial Services Compensation Scheme (FSCS), the industry backed lifeboat, which covers individual deposits of up to £50,000. At present, though, the FSCS is largely unfunded and is already relying on a £14 billion loan from the Government to cover its liabilities over the part-nationalisation of Bradford & Bingley.

The portion of deposits over £50,000 not covered by the FSCS will be met directly by the Treasury, although the hope is that the liquidation of assets of Kaupthing in the UK will cover the bulk of the costs.

Sources said last night that the management of the key part of the company, Kaupthing Singer & Friedlander Capital Markets, was close to securing a deal with Ernst & Young, the administrator, to buy it for only £1. The management of the stockbroking business is also looking for either a merger partner or a strategic investor.

In a demonstration of how fast Iceland’s crisis has accelerated, Kaupthing said that as late as September 26, directors believed the bank was performing well and that third-quarter results would be good. Among the losers is likely to be Sheikh Mohammed bin Khalifa al-Thani, a member of the governing family of Qatar, who spent more than £150 million picking up a 5 per cent stake in Kaupthing just two weeks ago, in what was intended to be a vote of confidence in the company.

The final straw came when Britain acted on Kaupthing Edge, which put Kaupthing in technical default, according to loan agreements. Geir Haarde, the Icelandic Prime Minister, said that he had not asked for help from the International Monetary Fund, which has sent a delegation to Reykjavik. However, he said that assistance from the fund was definitely an option and separate negotiations to secure a €4 billion (£3.1 million) loan from Russia would begin next Tuesday.

The effect of Iceland’s economic turmoil is already being felt in Britain. Kaupthing had become a key player in the British economy by taking stakes in many high street names, including Mitchells & Butlers, the pub group, and Debenhams, the department store chain. The bank nationalisation is expected to have major repercussions for companies as diverse as Somer-field, the retail giant Baugur, which owns brands like Whistles, and the Slug & Lettuce pub chain.

Iceland’s banking assets amounted to about nine times its gross domestic product and its current account deficit has billowed to 16 per cent of GDP last year.

Kaupthing’s nationalisation had an immediate impact on the leveraged loan market as the value of high-risk, high-yield loans slumped amid speculation more than €1 billion (£800 million) of debt being sold includes assets seized from Iceland’s banks.

Europe’s Markit iTraxx LevX index of credit-default swaps on loans to 75 companies dropped to a record low of 87.5, from 92.75 on Wednesday.

Iceland’s Financial Supervisory Authority (FME) said on its website that Kaupthing’s domestic deposits were fully guaranteed and that all its domestic branches, call centres, cash machines and internet operations would be open for business as usual.

“The Icelandic Financial Supervisory Authority has under powers granted by the Icelandic Parliament proceeded to take control of Kaupthing,” the financial regulator said. “The action taken by the FME is a necessary first step in achieving the objectives of the Icelandic Government and Parliament to ensure the continued orderly operation of domestic banking and the safety of domestic deposits.”

Kaupthing said that its board had resigned and that it had requested that the authorities take control.

The nationalisation of Kaupthing represents a fatal blow to the ambitious expansion drive by Icelandic banks into the UK.

Kaupthing was founded in 1982 with a handful of employees. However, it expanded dramatically as Iceland began to liberalise its markets. By 2005 – along with the Icelandic raider Baugur – Kaupthing was listed in both Stockholm and Reykjavik and was powerful enough to buy Singer & Friedlander, the 100-year-old commercial bank and asset manager based in the City, for £547 million. Kaupthing doubled in size each year between 1995 and the 2005 acquisition.

The bank had already begun to hire investment bankers of its own in London, telling colleagues and competitors that it had $1.9 billion (£1.1 billion) to spend on establishing itself in the heart of the business community.

As well as hoovering up Icelandic banks, including Bunadarbanki, Kaupthing bought Tyren Holding, the Norwegian asset manager, and Norvestia Oyj, the Finnish fund manager, before it arrived in the UK.

Landsbanki was less acquisitive, but sealed its reputation last year with the £60 million acquisition of Bridgewell, the stockbroker.

The disappointment at their failure this week has been palpable, as executives at UK subsidiaries have tried to buy their way out of the mess. Armann Thorvaldsson, KSF’s chief executive, told employees that he was “personally gutted” when the company was forced into administration.

Guernsey gloom

Thousands of British savers with Landsbanki Guernsey may not get their money back, it emerged yesterday.

The bank, a subsidiary of Landsbanki, offered some of the best offshore savings rates but savers in the UK and the Channel Islands are now unable to access their money.

The administrator said there were significant funds available and they were doing everything they could to enable part-payment to depositors and creditors to be made as soon as possible.

There is no deposit protection scheme in Guernsey.

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