By Frank Prenesti

LONDON (Reuters) - A diplomatic row has broken out between Iceland and Britain over how to deal with hundreds of millions of pounds of British deposits trapped in collapsed Icelandic banks.

Prime Minister Gordon Brown said Iceland's failure to guarantee the deposits was "completely unacceptable".

"This is fundamentally a problem of an Icelandic registered company (and) Icelandic registered financial services authority -- they have failed not only the people of Iceland, they have failed the people of Britain," he told the BBC.

His Icelandic counterpart Geir Haarde had earlier expressed anger at Britain's use of anti-terror laws to freeze Icelandic assets in Britain, and said he had made his views clear to Chancellor Alistair Darling in a telephone call.

"That was not very pleasant. I'm afraid that not many governments would have taken that very kindly, to be put in that category and I told the Chancellor that we were not pleased with that...I could not regard us in any way as the people that this act is supposed to apply to -- terrorists," Haarde told a news conference.

Brown remained unrepentant, saying he had been left with no other option.

"I think the public ... will understand that when people's savings and deposits are at risk, we are entitled to take the action that is necessary to seize the assets if we are not going to get any other way of making it clear that people... will find that their savings and deposits are safe," he told Sky television.

"Now we took that action -- I don't apologise for it. I think it is the right thing to do in the circumstances."  Continued...