A fully two‐way interactive nested primitive equation model of the Iceland‐Faeroe region is described. The model consists of a fine grid (approximately 3 km resolution) model nested 3:1 within a coarse grid (approximately 9 km resolution) larger area model. The fine grid model has increased resolution in both the horizontal and vertical directions. This allows better representation of coastlines and bottom topography, as well as of the ocean fields and dynamics. The model nesting technique used is suitable for relatively short‐term applications, for example, ocean forecasting or studies of mesoscale ocean processes. The nesting technique is found to be robust, with little noise or distortion produced at the interfaces between the model regions. Results from the nested model are compared with those from a coarse grid only model. Introduction of the nested fine grid model is seen to produce benefits in the form of tightened frontal gradients, increased meandering, and increased eddy activity; greater overflow of cold bottom water southward over the Iceland‐Faeroe ridge is also observed in the nested model. Calculations of the heat and volume transports through the Iceland‐Faeroe‐Shetland region show significant differences between the nested model and the coarse grid reference model. When the nested model is run in one‐way interactive mode, with no feedback from the fine grid model to the coarse grid model, increased noise is generated at the boundaries of the fine grid model.