Gordon Brown today said the British government planned to sue Iceland to recover the deposits of thousands of savers in the nation's stricken banks.

The chancellor, Alistair Darling, had earlier guaranteed that the government would cover deposits of British savers with Icesave, which yesterday stopped customers from withdrawing money from their accounts

The British government also seized control of Kaupthing Singer & Friedlander and put the business into administration, transferring the £2.5bn of retail deposits in its Kaupthing Edge accounts to ING Direct. Kaupthing is the largest bank in Iceland and the only one left of the big three still operating in private hands.

Iceland's woes deepened further this afternoon when Reykjavik put the third largest Icelandic bank Glitnir into receivership. The government had nationalised the bank two weeks ago but the central bank governor David Oddsson told Icelandic television that the "difficulties of the bank were much greater" than previously estimated.

The central bank also abandoned efforts to put a floor under its slumping currency by pegging it to the euro.

In a news conference today, Brown pledged legal action against the Icelandic government for refusing to honour its obligations after customers were prevented from taking money out of Icesave, an online British arm of Iceland's second biggest bank Landsbanki.

Landsbanki was taken over by Icelandic authorities yesterday after emergency legislation designed to prevent the tiny nation's economy going into a complete meltdown.

"We are showing by our action that we stand by people who save," Brown said.

"We are taking legal action against the Icelandic authorities, to recover the money lost to people who deposited in UK branches of its banks."

Iceland has suffered a tumultuous few weeks. The country's government is scrambling to save the economy from collapse and has asked Russia for a €4bn loan.

It has introduced emergency laws earlier giving the government sweeping new powers to take over banks, force them to merge or even into bankruptcy.

But the country appeared to sink deeper into the financial crisis today.

Sweden is granting liquidity assistance to the Swedish arms of Kaupthing, with a total loan of up to 5bn crowns (£400m).

ING Direct UK, the British division of the Dutch bank, is buying more than £3bn of deposits held by around 180,000 British savers with Kaupthing Edge, the UK arm.

The group also signed an agreement with the Treasury to acquire deposits from Heritable Bank, another British division of Landsbanki.

Today's action by Sweden comes a day after the Icelandic prime minister, Geir H Haarde, publicly criticised the lack of assistance the country has received from Europe.

The central bank said it believed that Kaupthing was solvent, but was suffering temporary liquidity problems that could have wider repercussions.

"To safeguard financial stability in Sweden and ensure the smooth functioning of the financial markets, the Riksbank has therefore decided to grant liquidity assistance to Kaupthing Sverige," it said in a statement.

With the deregulation of its financial market in the mid-1990s and subsequent stockmarket boom, Iceland had transformed itself into one of the wealthiest nations in Europe.

Many Icelandic banks and companies have invested heavily in Europe, making it even more important to ensure that turmoil is contained.

Kaupthing has also invested in European retail groups, and racked up debts of more than $5.25bn (£3bn) to help fund British deals.

The Icelandic government said today that it had extended its own $680m loan to Kaupthing to tide it over.

Trading in the bank was halted on the Nasdaq-OMX, after its shares plunged 34% this morning.