Iceland's parliament approved an amended bill late on Wednesday to repay more than $5 billion lost by savers in Britain and the Netherlands when the island's banks collapsed during the financial crisis.
The passage of the legislation, backed by a 33-30 margin by members of parliament, boosts Iceland's hopes of swift entry to the European Union and of getting its shattered economy back on track.
Approving the bill is the better option and will avoid even more economic damage, Steingrimur Sigfusson, finance minister and leader of the Left-Green party, said during the debate.
History will show that we are doing the right thing.
Britain had no immediate comment on the news, but Dutch Finance Minister Wouter Bos welcomed the bill.
It has not been an easy process but Iceland has taken its responsibility and that deserves a compliment, he said in a statement on Thursday.
The global financial crisis devastated Iceland's economy, bringing down its top banks, sending its currency tumbling and plunging the country into recession.
The economy is expected to contract more than 8 percent this year as the effects of last year's economic meltdown linger, with growth not returning until 2011.
To cushion the worst of the fall-out, Iceland has signed up to a $10 billion aid package from the International Monetary Fund and other lenders.
But the row with Britain and the Netherlands held up initial payments by the IMF and has made it difficult for the country to relax exchange controls -- put in place at the height of the crisis -- for fear the fragile krona currency will plunge again.
The Icesave spat has also clouded Iceland's bid to join the EU, seen as crucial to ensure long-term economic stability.
Iceland has now started to draw on funds from the IMF and other lenders and the second review of the aid program is due to take place in the middle of January.
Reykjavik struck an initial deal in August to reimburse the two EU nations for bailing out investors who lost money held in high-interest online savings accounts when Iceland's financial system cracked under the pressure of the global credit crunch.
But Britain and the Netherlands balked at changes to the so-called Icesave bill introduced by the Icelandic parliament that would have meant the government's repayment guarantee running out in 2024.
Iceland's coalition government has struggled to push the new bill -- extending the payment guarantee -- through parliament.
The Icesave bill is deeply unpopular with the Icelandic population and there is widespread resentment that taxpayers are being left to foot the bill for mistakes made by financial firms operating under the watch of other national regulators.
(Additional reporting by Ben Berkowitz in Amsterdam; Editing by Elizabeth Fullerton)