Reykjavik - The Icelandic government adopted an "emergency law" late on Monday to reorganize its financial system that has been severely battered.

Prime Minister Geir Haarde said in a televised speech to the nation that the bank crisis also posed a national threat.

"There is a very real danger, fellow citizens, that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could be national bankruptcy," he said.

The new legislation was to "adapt the banking system to Icelandic circumstances and rebuild the trust of foreign operators in Icelandic banking and financial operations," Haarde said.

The commercial banks in the North Atlantic nation of 300,000 people have rapidly expanded their operations in recent years, and "their liabilities are now equivalent to many times Iceland's GNP," Haarde added.

Under the special powers, he said the government "aimed for the sale by Icelandic banks of foreign assets and a reduced presence abroad, so that the Icelandic state, so small in comparison with the Icelandic banks, would have the capacity to support them."

The measures came after the Icelandic Financial Supervisory Authority on Monday said it was temporarily suspending trading of shares and other financial instruments issued by several banks including Glitnir bank, Kaupthing bank and Landsbanki.

Haarde said the government would "fully" cover all deposits in domestic commercial and savings banks.

The nation's largest bank Kaupthing said over the weekend its finances were healthy.

A week ago, the government of Iceland bought a majority stake in Glitnir bank.

The government paid 600 million euros (877 million dollars) for a 75-per-cent stake in Glitnir, saying the move was aimed at strengthening Glitnir's capital ratio and liquidity.

The Icelandic currency, which came under attack from speculators earlier this year, has dropped in value compared to the euro and the dollar, with the country suffering from some 15-per-cent inflation.