By Rowena Mason Published: 8:15PM BST 06 Jul 2009  A man walks out of a branch of Landsbanki in Reykjavik, Iceland. The Treasury froze the bank's assets as security in case Iceland refused to compensate British savers Photo: AP  A diplomatic row erupted between the two nations after Landsbanki, the parent bank of Icesave, failed last October affecting 300,000 British savers.  But private correspondence reveals that relations were even frostier than publicly disclosed after the Treasury froze the assets of Landsbanki as security in case Iceland refused to compensate British savers.  A letter from Ingibjorg Solrun Gisladottir, Iceland's then foreign minister, addressed to the UK several weeks after the crash highlights the disastrous impact on the Icelandic economy.  "Total possible liabilities, if pushed to their maximum, could impose on Iceland reparations on a similar economic scale to the Treaty of Versailles," the letter dated October 23 said.  Another major objection was the Anti-Terrorism, Crime and Security Act used by the Treasury to freeze the assets, putting Iceland on a list of suspect organisations.  "It makes no sense to see an Icelandic company listed next to the Al-Qaeda and the Taleban on the Treasury website," she wrote.  Two further letters from Arni Mathieson, the then finance minister, to Alistair Darling in December and January received no answer from the Treasury.  A senior Treasury adviser, Clive Maxwell, finally sent a 12-page response in mid February explaining the UK's refusal to lift the legislation while the terms of compensation were still under dispute.  Mr Maxwell accused Iceland's plans for compensation of being opaque and contradictory.  He also said too many of Landsbanki's assets had been put into a new bank for domestic customers. This left creditors of the old bank – such as UK charities and councils – with fewer assets to cover their claims.  The UK lifted the freezing order last month, after it agreed to give Iceland a £1.3bn loan at 5.5pc interest rates to pay Icesave savers 20,887 euros (£18,000) each.
The bitter state of relations between Iceland and Britain over the collapse of    Icesave has emerged in official documents warning the UK that it was    inflicting damage equal to the Treaty of Versailles.