LONDON (Reuters) - A diplomatic row broke out between Iceland and Britain Thursday over how to deal with hundreds of millions of pounds of British deposits trapped in collapsed Icelandic banks.

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Prime Minister Gordon Brown said Iceland’s failure to guarantee the deposits was “completely unacceptable.”

“This is fundamentally a problem of an Icelandic registered company (and) Icelandic registered financial services authority -- they have failed not only the people of Iceland, they have failed the people of Britain,” he told the BBC.

His Icelandic counterpart Geir Haarde had earlier expressed anger at Britain’s use of anti-terror laws to freeze Icelandic assets in Britain, and said he had made his views clear to Chancellor Alistair Darling in a telephone call.

“That was not very pleasant. I’m afraid that not many governments would have taken that very kindly, to be put in that category and I told the Chancellor that we were not pleased with that...I could not regard us in any way as the people that this act is supposed to apply to -- terrorists,” Haarde told a news conference.

Brown remained unrepentant, saying he had been left with no other option.

“I think the public ... will understand that when people’s savings and deposits are at risk, we are entitled to take the action that is necessary to seize the assets if we are not going to get any other way of making it clear that people... will find that their savings and deposits are safe,” he told Sky television.

“Now we took that action -- I don’t apologise for it. I think it is the right thing to do in the circumstances.”

British officials have said repeatedly this week that they were having difficulty “getting complete clarity” from Icelandic authorities on how British savers were exposed and whether they would be able to recover their deposits.

It emerged Thursday that 108 British local councils had a total of 799 million pounds on deposit with Icelandic banks.

Most of them will be able to continue to provide services, but the British government said it would help any councils with short-term cash flow problems on a case-by-case basis.

Iceland has taken control of three banks this week: Kaupthing, Landsbanki and Glitnir.

The British government has pledged to protect the deposits of all British retail savers with those banks, but has not extended this guarantee to corporate investors.