Iceland refused to pay the sum, as its financial crisis had nearly bankrupt the entire country, prompting the UK to invoke terrorist legislation to seize Landsbanki's UK assets.
The UK has since been pressing Iceland to repay not just the £2.35bn of principal but also the interest bill to British taxpayers. Initially, the UK requested interest of 5pc before adjusting its demand to between 3pc and 3.3pc a year from 2009 to 2016. Both requests were rejected by the Icelandic public in two referendums.
The EFTA court has now ruled out any prospect of the UK suing Iceland for the interest cost, and clarified that governments are not liable to cover the cross-border depositor guarantee obligations of their banks. It effectively saves the Icelandic government more than £100m that would have been paid under the second Icesave Agreement.
A Treasury spokesman said: "We are being reminded again of all that went wrong in our system of financial regulation, which we are still paying the price for."
The UK taxpayer is on course to recover almost everything, as Landsbanki's administrators have confirmed that the estate has more than enough money to cover the £2.35bn principal and £100m in official penalties that applied until 2009. Asked if Britain might demand further interest, though, Iceland's Prime Minister Johanna Sigurdardottir on Monday said: "They are in no position to do so."
The ruling also makes a mockery of the cross-border European banking rules. Governments are currently prohibited from stopping a bank operating in the country while remaining subject to the host nation's regulator. The court ruling means that host nations have no responsibility for foreign depositors in the event of a collapse. Savers can only recover their money from the bank directly, through the administration process, which could take years.
Jóhannes Karl Sveinsson, Iceland's Supreme Court Attorney, said: "This is cross-border banking. The EU has an enormous problem [with it]. They are trying to improve the situation. I would think this ruling would give them a reason to speed up what they are doing."