The Treasury today guaranteed that no British customers of Icesave would lose their savings after the Icelandic online bank collapsed yesterday.

The Prime Minister issued a blanket guarantee that the 300,000 UK customers would get all their money back – and he threatened legal action against the Icelandic authorities to force it to honour its duty to compensate savers.

Treasury officials went further, making clear that it will ensure that Icesave customers recover all their cash, up to and above the £50,000 limit.

Savers will be able to make a single application to Britain's Financial Services Compensation Scheme for the return of all their money. In addition, customers with Icesave ISAs have been reassured that their cash will not lose its tax-free status.

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The Treasury has also arranged for more than £3 billion of UK savers’ money that is held with two other Icelandic banks, Kaupthing Edge and Heritable Bank, to be transferred to ING Direct UK, a subsidiary of Dutch savings bank ING.

Icesave, the online British arm of Landsbanki, Iceland’s second biggest bank, announced yesterday that its customers could no longer withdraw or deposit money. Landsbanki was taken into receivership by the Icelandic authorities and its board of directors was fired.

Yesterday the Icelandic prime minister indicated that Landsbanki was still operational and would be able to repay the money deposited by British savers, but the financial turmoil in the tiny Nordic country appeared to have worsened overnight.

"The Icelandic government have told me, believe it or not, they have no intention of honouring their obligations there," Alistair Darling, the Chancellor, told BBC radio this morning.

Citing "exceptional circumstances" he said: "We have decided we will stand behind those savers."

Mr Brown later told a No 10 news conference that Britain stood ready to sue Iceland to honour its responsibilities. "We are taking legal action against the Icelandic authorities, to recover the money lost to people who deposited in UK branches of its banks," he said.

More than 300,000 British customers had around £4 billion deposited in Icesave accounts, with the average saver having about £15,000 with the bank. Some had much more than this, though. One saver, Peter Amodio, has told The Times that he had £180,000 on deposit with Icesave. Another saver had her £200,000 life savings there.

Icesave was one of a handful of banks to claim the so-called passport exemption - meaning that savers are supposed to apply to the Icelandic authorities for the first €20,887 (£16,170 pounds) they have lost, with the British compensation scheme topping up the rest.

Today’s developments ensure that this laborious process will no longer be necessary for British savers as the Government will recover the money on their behalf. The Treasury said that the FSCS was working with the Deposit Insurance Scheme in Iceland to ensure that depositors were paid back as quickly as possible, while Mr Darling has also spoken to the Icelandic Finance Minister, urging him to give UK depositors the same protection as those in Iceland.

The Treasury statement offered reassurance for British customers of other Iceland banks.

ING is to acquire £2.5 billion of deposits and 160,000 customers from Kaupthing Edge, which is thought to represent all of the UK operations of Iceland’s biggest bank Kaupthing. It is also acquiring £538 million of savings held by 22,200 people with Heritable Bank, which is a subsidiary of Landsbanki and was placed into administration with Ernst & Young yesterday.

The Heritable Bank transfer is being backed by money from the Treasury and Financial Services Compensation Scheme (FSCS).

The Chancellor has also frozen the assets that Landsbanki holds in the UK until the future of the bank and the position of UK creditors becomes clearer.

Kaupthing is a separate bank to Landsbanki, and it insists it is financially sound. Given the events of this week, however, which have also seen the Icelandic government pass emergency legislation enabling it to take control of the country’s banks, savers are likely to feel happier that their money is now in different hands.

Fears over the health of the Icelandic financial sector have been growing for weeks as the country wrestled to maintain stability in its financial sector. Last week it nationalised its third largest bank Glitnir, and on Monday the Icelandic prime minister warned earlier that the island faced the "real possibility" of "national bankruptcy" as its economy could be sucked into the "global banking swell".

Icesave's website remained frozen today. "We are not currently processing any deposits or any withdrawal requests through our Icesave internet accounts. We apologise for any inconvenience this may cause our customers," read a message on the site. "We hope to provide you with more information shortly."

Meanwhile, its customers have been venting their fury.

Steve, 48, a textile management agent from Derby, central England, said: "My wife and I need to pay up to £12,000 for renovations on our bungalow next week and I have no idea if we’ll be able to access our money to do so.

"I’ve been panicking this morning and I can’t concentrate on my work. I’m worried we’ll lose all the money if the Icelandic government doesn’t have enough in its coffers to guarantee everyone’s savings."

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