The scheme will cost the government £11m
Payments of £1,000 to depositors with Kaupthing, Singer and Friedlander Isle of Man (KSFIOM) bank have been welcomed by a member of a Manx action group.
Nick Campling from the KSFIOM Depositors' Action Group said the move showed "extreme goodwill" on the part of the Isle of Man government.
The payments were proposed by Treasury Minister Allan Bell and approved by Tynwald on Wednesday.
The £11m scheme will be financed by the government's reserve fund.
Mr Campling added that both the Isle of Man and UK governments must take responsibility for what has happened.
A winding-up petition for the bank, which collapsed in October, has been adjourned twice while government officials seek an alternative to liquidation.
If the bank is wound up, the Depositors' Compensation Scheme will be triggered, providing payments of up to £50,000 for individual depositors and up to £20,000 for other account holders.