By Omar Valdimarsson
REYKJAVIK (Reuters) - Iceland took over its second largest bank, propped up its battered currency and said Russia would lend it 4 billion euros ($5.44 billion) to help it through a financial meltdown that threatens to overwhelm the economy.
But, clouding a rapidly-escalating crisis, Russian deputy finance minister Dmitry Pankin told Reuters no decision had been taken to lend money.
Home to 300,000 people, Iceland used emergency powers adopted on Monday to dismiss the board of directors of Landsbanki
That drove the country's crown currency 35 percent lower, but it bounced back after the central bank said Moscow had agreed to step in.
So volatile was the currency that the central bank was forced to introduce a currency peg at a value of 131 per euro. It was last trading at 144 per euro.
Commerce and banking minister Bjorgvin Sigurdsson said Landsbanki would be open and run as normal while the changes were taking place. Iceland's Financial Supervisory Authority (IFSA) had replaced the bank's board with its own people.
"Domestic deposits are fully guaranteed, as declared by the government. Landsbanki's domestic branches, call centers, cash machines and internet operations will be open for business as usual," the IFSA said in a statement.
"The objective of the IFSA's action is to guarantee a functioning domestic banking system."
The central bank, Sedlabanki, said the Russian loan would substantially strengthen Iceland's foreign reserves and support the crown.
Sedlabanki said the loans were for 3-4 years on terms that would be 30-50 points above Libor rates and that Icelandic Prime Minister Geir Haarde had begun investigating the possibilities of such a loan this summer.
"Four billion euros would be more or less what Iceland needs to cover the whole banking system assets with their reserves," said Elisabeth Gruie, currency strategist at BNP Paribas.
"It's also a surprising move for Russia that reflects its desire to reaffirm itself as a world power."
EMERGENCY BILL RUSHED THROUGH
Iceland's biggest bank, Kaupthing
Threatened with national bankruptcy, Iceland adopted sweeping powers over banks late on Monday as its financial system tottered and its currency plunged.
The ruling alliance and opposition parties united on a bill that gave the state the ability to dictate banking operations, including provisions that allow it to push through mergers or even force a bank to declare bankruptcy.
Parliament passed the bill and its provisions took immediate effect.
Investment firm Exista kicked off on Tuesday what is expected to be a string of Icelandic asset sales, saying it will sell its near 20 percent stake in Finnish insurer Sampo to reduce liabilities.
Kaupthin said Iceland's central bank had lent it 500 million euros. It said it had not been approached by the state's financial regulator.
Iceland has found itself perched on a faultline in the global financial turmoil.
"We were faced with the real possibility that the national economy would be sucked into the global banking swell and end in national bankruptcy," Prime Minister Geir Haarde told the nation late on Monday.
The North Atlantic island has punched far above its weight in financial terms as its banks expanded overseas, investors took large positions in its high-yielding currency and foreign firms poured money into local projects.
(Writing by Mike Peacock; editing by Patrick Graham; London Treasury Desk +44 207 542 4441)