REYKJAVIK, Iceland (AP) - Iceland plunged further into financial crisis yesterday as it scrapped plans to nationalise a major bank, instead placing it into receivership, and abandoned attempts to put a floor under its falling currency by fixing the exchange rate.

The financial strife also developed into a diplomatic spat as the British government said that it planned to sue over lost deposits held by tens of thousands of Britons with Icelandic bank accounts. The threat prompted Prime Minister Geir Haarde to issue a statement saying the Nordic country was working toward a "mutually satisfactory solution".

The global credit crisis has exacted a heavy toll on Iceland, where the banking sector dwarfs the rest of the economy thanks to a stock market boom in the mid-1990s.

Those heavily exposed banks are now putting the entire country at risk, with Haarde warning of "national bankruptcy".

The struggle of the government to deal with its top-heavy banking system was highlighted by a decision to place Glitnir, the country's third largest bank, into receivership under the Icelandic Supervisory Authority. The decision came less than two weeks after the government announced it was taking a 75 percent stake in the bank for 600 million Euros. Central bank governor David Oddsson told TV station RUV late on Tuesday that the "difficulties of the bank were much greater" than previously estimated.

The move into receivership gives Glitnir temporary protection from its debt obligations.

A receivership committee appointed by the regulator has replaced Glitnir's board and immediately began restructuring the bank with announcements that it plans to sell its Finnish and Swedish businesses.

Meanwhile, the Icelandic central bank, Sedlabanki, said it was giving up attempts to peg its currency to stop the kronur free-falling.

The bank had temporarily fixed the exchange rate of the krona at a level equal to 131 krona against the euro - on Tuesday morning.

Earlier yesterday, it made a plea that "market makers in the interbank market support its attempts to strengthen the krona", which went unheeded.

"It is clear that there is insufficient support for this exchange rate; therefore, the bank will not make any further such efforts for the time being," it said in a statement.

The country was also forced to defend its stance over the standing of some 300,000 Britons who hold accounts with IceSave, the Internet arm of Landsbanki, the country's second largest bank that was placed into receivership.