Iceland's top three banks all collapsed in late 2008 after years of debt-fuelled expansion. The country of just 320,000 people was forced to borrow around €7.57 billion from the International Monetary Fund and other lenders.
Parliament voted in 2010 to prosecute Haarde over the crisis at a special court of impeachment set up in 1905, which has never been used before. He has denied the charges.
"None of us realised at the time that there was something fishy within the banking system itself, as now appears to have been the case," Haarde told the court in opening questioning from the special prosecutor investigating crimes linked to the crisis.
Many Icelanders blame a small and closely connected group of businessmen, bankers and politicians for the crisis.
Haarde is charged with gross negligence for failing to take proper measures to prepare for an impending financial crash.
He is also accused of failing to rein in banks which grew their balance sheets to around nine times the size of the island's economy in the years preceding the crisis.
Haarde, prime minister from 2006 to early 2009, faces up to two years in prison if he is found guilty.
Iceland's biggest banks were all taken over by the state in late 2008 after the credit crunch provoked by the fall of Lehman Brothers froze their access to funds.
Iceland ring-fenced the domestic operations of the banks and let their international operations go bankrupt.
The economy nosedived and the country was forced to impose capital controls to prop up the value of its krona currency. It also became embroiled in a damaging fight with Britain and the Netherlands over €3.78 billion of losses suffered by depositors in foreign accounts of Icelandic banks.
The economy has started to recover from the crisis, having borrowed on the international bond markets last year and getting its investment grade back from Fitch in February.
Prosecutors say the government had a duty to step in to prevent the banks becoming too big to save in the event of a crisis and handing the burden of their debts onto taxpayers.
In February, top executives at Kaupthing Bank were indicted on charges of fraud and market manipulation.