The North Atlantic nation has been hit hard by the global credit crunch. The current government has been under pressure since then and on Monday succumbed, with the prime minister to hand in his resignation.
The government of Iceland was to resign Monday in the wake of the financial turmoil that hit the North Atlantic nation, Prime Minister Geir Haarde said.
Haarde, who last week said he was suffering from cancer and was to step down as leader of the Independence Party at the party conference in March, said the coalition with the Social Democrats has ended with immediate effect.
The coalition was formed after elections in 2007.
Iceland has experienced a wave of protests since October when the country's three banks Glitnir, Landsbanki and Kaupthing were nationalized after almost collapsing due to the global credit crunch.
The premier, 57, was later Monday to hand in is resignation to the president.
Elections to be held early
At his announcement last week, Haarde said his party favored early elections to be held May 9 -- two years early. He did not offer new details Monday.
Haarde last week said he is to undergo treatment for a small malignant tumor of the esophagus at a hospital outside Iceland at the end of this month or in February.
The premier had until last week resisted increasing pressure to call early elections, arguing that such a move risked slowing down measures to counter the crisis.
Economy contracting
The North Atlantic nation of some 320,000 people is facing a severe contraction of its economy with unemployment due to rise sharply.
Interest rates are at 18 percent and the country recently secured a $2.1-billion loan from the International Monetary Fund.
Haarde has been prime minister since 2006 after previously serving as foreign minister and finance minister. He formed a coalition after elections in 2007 with the Social Democrats as junior partner.
The leader of the Social Democrats, Foreign Minister Ingibjorg Solrun Gisladottir, recently returned to Iceland after undergoing medical treatment in Sweden.
The coalition government in Iceland has collapsed following the international banking crisis.

Icelandic Prime Minister Geir Haarde 

Prime Minister Geir Haarde of the conservative Independence Party had begun talks with coalition partner party Social Democratic Alliance in the run-up to an early general election planned for May. It was reported yesterday that these talks had failed and the coalition was dissolved. The centre-left Social Democrats will now try to build a coalition with opposition parties, according to the BBC.

The Independence Party currently has 25 of the 63 seats in the country's unicameral Althing (parliament), and the Social Democratic Alliance holds 18 seats. The remainder of the government consists of the Left-Green Movement (9 seats), the Progressive Party (7) and the Liberal Party (4).

The coalition was formed after the election in 2007, but became uneasy after the global financial crisis caused Iceland to nationalise its banking system and ask for help from the International Monetary Fund, with Social Democrats seeking closer ties with the European Union and the replacement of the head of the central bank. Social Democrat leader and Foreign Minister Ingibjörg Gísladóttir has suggested Jóhanna Sigurðardóttir, the Social Affairs and Social Security Minister, as the next prime minister.

Iceland's interest rate is now 18%, with GDP expected to fall 9.6% this year. Inflation has reached 13.1%.