NEW YORK (MarketWatch) -- Iceland's government announced on Monday a $2.1 billion recapitalization plan for its three leading banks in a major step to resuscitate its troubled financial sector.

The finance ministry in Reykjavik said Monday that it will recapitalize the three new banks -- Islandsbanki, New Kaupthing and New Landsbanki -- created following the collapse of the main Icelandic commercial banks last October.

The government will recapitalize the three banks on August 14 by issuing new government bonds to the banks. Under the plan, control of two of the three banks will be transferred from the government into private hands.

The total capitalization will amount to approximately 270 billion Icelandic kronur ($2.1 billion), the ministry said in a statement posted on its Web site.

Iceland's finance minister, Steingrímur J. Sigfússon, called the plan "a major step forward in the re-establishment of a strong banking system."

"They allow for the recapitalization of the banks, potentially at a significantly lower cost to the taxpayer than originally envisaged," Sigfússon said. Last October, the estimated capital commitment was 385 billion kronur.

The tiny island nation was plunged into economic chaos late last year when its banks collapsed and its currency plunged. To stabilize its economy, Iceland was forced to secure a $2.1 billion bailout from the International Monetary Fund. Last week, Iceland's parliament voted in favor of a government proposal to apply for membership of the European Union.

Two banks will become private

Iceland's three main commercial banks -- Glitnir, Landsbanki and Kaupthing -- could not refinance themselves last October and were consequently taken into administration by the government.

The finance ministry said Monday that it has conditionally agreed with the resolution committees of Glitnir and Kaupthing that they should have majority ownership of the new banks.

As a result, shares in Islandsbanki and New Kaupthing will be held by Glitnir and Kaupthing, wile the government will continue its involvement through significant capital support and board representation.

If Glitnir and Kaupthing complete their subscription agreements, the total cost of the recapitalization would be reduced to about 200 billion kronur, the finance ministry said.

The government will recapitalize Islandsbanki with 60 billion kronur and Glitnir is expected to own 100% of Islandsbanki. Also, the government will recapitalize New Kaupthing with 70 billion kronur; 87% of the bank is expected to be owned by Kaupthing and 13% by the government.

The third bank, New Landsbanki, will remain in government ownership and will receive 140 billion kronur from the state. The bank is also expected to issue bonds as part of the recapitalization plan.

Venla Sipila, analyst at IHS Global Insight, said the plans "mark significant progress in stabilizing the whole financial sector, including the foreign-currency market."

Sipila warned, however, that several steps still need to be taken before Iceland returns to financial stability.

"The plans now have to be finalized, approved, and then implemented, and it may emerge that more capital is still needed in order to get the banking sector back on its feet," Sipila said in a note to clients.