Iceland's government has taken control of the country's largest bank as it struggles to prevent a collapse in its entire banking system.

Thursday's decision to take over Kaupthing means that all three of the Nordic country's major banks are now under the control of Iceland's Financial Supervisory Authority.

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

Iceland has already lent $745 million to Kaupthing to help the bank stay afloat.

The authority 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.

In a demonstration of how fast Iceland's crisis is moving, officials at Kaupthing said that as late as Sept. 26, directors believed the bank was performing well and that third-quarter results would be good.

The final straw for the bank came when Britain transferred control of the business of Kaupthing Edge, its internet bank, to ING Direct and put Kaupthing's UK operations into administration, which meant Kaupthing was in technical default according to loan agreements.

"It did not matter that the parent company had sufficient liquidity and its position was solid," Kaupthing said in a statement.

Risk of national bankruptcy, says PM

The government has already seized control of Landsbanki and Glitnir after Prime Minister Geir H. Haarde warned that the country was at risk of "national bankruptcy."

Iceland adopted sweeping powers on Monday that gave the state the ability to dictate banking operations and allow it to push through mergers or even force a bank to declare bankruptcy.

Iceland had recently expanded its banks overseas and investors took large positions in its high-yielding currency and foreign money poured into local projects.

"What we have learned from this whole exercise over the last few years is that it is not wise for a small country to try to take a leading role in international banking," Haarde said in an interview on Wednesday.

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

Haarde said he had not asked for help from the International Monetary Fund, which has sent a delegation to Reykjavik. But he said assistance was "definitely an option."

Iceland is also in separate negotiations with Russia to secure a $5.45-billion loan.