Cyprus buys time to pursue bailout options

March 20, 2013: 2:49 PM ET
Cyprus goes back to the drawing board
LONDON (CNNMoney)

Banks in Cyprus will remain shut until early next week to prevent a catastrophic flight of capital after efforts by its leaders and European officials to come to terms on a bailout made little progress Wednesday.

The Cypriot parliament blocked a €10 billion rescue plan by the European Union Tuesday by rejecting a tax on bank deposits that would have helped fund the rescue.

In the aftermath of that vote, President Nicos Anastasiades met the leaders of Cyprus' political parties and officials from the European Commission, European Central Bank and International Monetary Fund to try to salvage the bailout.

But the talks failed to achieve a breakthrough. The central bank was forced to announce that, in the interests of preserving financial stability, the country's banks would not open at all this week.

Without agreement on a bailout, policymakers fear depositors will rush to withdraw cash, pushing the country ever closer to bankruptcy.

Under the EU plan, Cyprus agreed to raise €5.8 billion to prevent the country's debt from ballooning to unsustainable levels, but rejection of the controversial tax on deposits has left it scrambling to find alternative sources of funding.

In other talks at the central bank of Cyprus on Wednesday, teams looked at the "financing and reduction" of the €5.8 billion amount, a government spokesman said.

At the same time, Finance Minister Michalis Sarris met officials in Moscow to discuss whether Russia would be prepared to ease the terms of an existing €2.5 billion loan, and perhaps provide additional financing. Anastasiades also spoke by telephone with Russian President Vladimir Putin.

Related: What next for Cyprus?

Russia has extensive business and banking ties to the tiny Mediterranean island and was angered by the proposed bank levy, which would have clawed back 10% of all deposits over €100,000, and a smaller percentage on deposits of more than €20,000.

For the first time, bank depositors were asked to contribute to a eurozone bailout, provoking outrage in the Cypriot parliament and widespread condemnation for a measure that also included small deposits covered by a national guarantee scheme.

The EU deal, agreed in the early hours of Saturday, sent Cypriots racing to withdraw money from bank cash machines over the weekend, and raised fears of a broader run on the country's ailing banks.

Cyprus' banking sector is several times the size of its economy and it sustained heavy losses on Greek government debt when a haircut on bondholders was imposed as part of an EU bailout.

Related: U.K. flies cash to Cyprus for soldiers

They are being kept afloat by emergency funding from the European Central Bank, a lifeline that can't continue indefinitely, according to one of the bank's executive board members.

"We haven't made any threats but rather pointed out as a matter of fact that we can only provide emergency liquidity to banks that are solvent, and the solvency of Cypriot banks can't be taken for granted without early agreement on an aid program that would allow a rapid recapitalization of the banking sector," Joerg Asmussen told German newspaper Die Zeit.

There are few alternatives for Cyprus to escape its financial crisis, given its immediate funding needs total nearly €17 billion, almost equivalent to the size of its economy.

Eurozone policymakers insisted they would not repeat the Greek government bond haircut and tapping bank bondholders won't raise nearly enough cash. Further tax rises on top of a proposed increase in corporate tax would drive the economy even deeper into recession and drive up borrowing.

Some local media reports suggest the government may tap social security reserves or convert bank deposits into long-term bonds, backed by revenue from Cyprus' as-yet undeveloped natural gas deposits.

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