Cyprus banks reopen with tough cash limits

March 28, 2013: 12:35 PM ET
LONDON (CNNMoney)

Banks in Cyprus opened Thursday for the first time in nearly two weeks with strict limits on cash withdrawals as authorities tried to prevent money from draining out of the economy following a bailout by the European Union.

Cyprus became the first eurozone country since the currency was launched on Jan. 1, 1999, to place restrictions on how much money individuals and companies can take across its borders after confidence in its outsized financial system was shaken by the bailout terms.

Queues formed outside bank branches in the capital of Nicosia amid tight security but there was no evidence of panic. The stock exchange said it would remain shut until April 2 to give market participants time to adjust to the restrictions on financial transactions.

"I think there's been remarkable tolerance by the people of Cyprus," said Carl Bildt, foreign minister of Sweden, which suffered its own banking crash in the 1990s.

"I'm not particularly pessimistic about the long-term future for Cyprus - it's going to be difficult days now for some time but not for the long term," he told CNN.

Related: Calm, long lines as banks reopen

The banks had been shut since March 16 as it became clear that deposits would be raided as a condition of the 10 billion euro bailout.

The tiny island nation was brought to the brink of financial collapse and possible exit from the eurozone after its two biggest banks -- Bank of Cyprus and Popular Bank -- took big losses on Greek government debt, wiping out a third of their combined capital.

After months of negotiations, it signed up Monday for a bailout from its eurozone partners, backed by the International Monetary Fund, worth nearly 60% of gross domestic product.

In return, Cyprus committed to raise billions from big depositors to fund the winding down of Popular Bank and to recapitalize Bank of Cyprus. The EU wants Cyprus to shrink its banking industry to average size by 2018, which means shedding about half its assets.

Deposits above 100,000 euros have been frozen at both big banks. They could be wiped out entirely at Popular, while at Bank of Cyprus about 40% will be converted into equity.

Related: Tough times for Cyprus after EU bailout

All deposits of less than 100,000 euros are guaranteed. And the bailout does not affect smaller banks in Cyprus, which account for about 60% of the country's total deposits of 68 billion euros.

Many of those deposits belong to foreign investors, in particular Russians, and Cypriot authorities fear an uncontrolled flight of capital that would cause the economy to implode.

The use of controls breaks new ground for the EU, which is founded on the principle of free movement of capital and payments. Some economists argue that a partial break-up of the eurozone is underway as a euro held in Cyprus is no longer worth the same as a euro held in Germany.

Related: Bitcoin prices surge post-Cyprus bailout

Credit and debit card use abroad has been limited to 5,000 euros per month, and people leaving Cyprus can only take 3,000 euros in cash each trip.

Cyprus has banned the early withdrawal of funds on term deposits and transfers of more than 5,000 euros abroad, unless approved for trade purposes. Checks can be paid into accounts but not cashed, and a daily withdrawal limit of 300 euros has been set.

The European Commission said the controls were justified for an initial period of a week, but said they should be lifted as soon as possible.

"The commission will continue monitoring the need to extend the validity of, or revise, the measures," the commission said in a statement.

The longer the strictures remain in place, the greater the potential loss of confidence in other small eurozone states with large banking industries.

And even if it manages to stabilize the banking system and relax controls, Cyprus faces years of hardship as the shrinking of one of its main service industries plunges the economy even deeper into recession.

"A sharp contraction in Cypriot GDP of around 10% to 20% is likely in 2013-14 with only a weak recovery thereafter," noted forecasters at Oxford Economics. "It is difficult to avoid the conclusion that Cyprus will require additional bailouts in the future."

Development of natural gas deposits discovered offshore may ease the pain, but they're unlikely to begin generating significant revenue for several years.

"The EU deal was tough and what worries me is the next packet of measures they will try to impose,"said CNN iReporter George Georgiou. "Is it going to be worse or better? Nobody knows. Do we have a future with this deal?"

--CNN's Ivan Watson contributed to this report from Nicosia.

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