Cyprus banks face collapse after legislators reject levy

Talks were under way last night between Cyprus, Russia and the European Union to reach a deal preventing the Cyprus's banking sector from collapse.

Depositors have been withdrawing their money from Cypriot banks in the past few days. Louisa Gouliamaki / AFP

The handling of the banking crisis in Cyprus has tarnished the image of euro-zone policymakers whatever the eventual outcome, analysts warned yesterday.

Talks were under way last night between Cyprus, Russia and the European Union to reach a deal preventing the country's banking sector from collapse.

The future of Cyprus's banking industry was thrown into turmoil yesterday after the country's house of representatives rejected a plan to impose a levy on bank deposits.

Legislators struck down a 6.75 per cent tax, which would have increased to 9.9 per cent on those with funds of €100,000 (Dh474,851). Not a single vote was cast in favour of the deal following mass protests against the levy and fears of bank runs.

Cyprus's banks, dependent on emergency funding lines from the European Central Bank, remained closed yesterday but were due to reopen today. A team of experts was rushed to Cyprus's central bank yesterday to formulate a "plan B", the government spokesman, Christos Stylianides, said. "The president of the republic of Cyprus expresses his absolute respect for the decision taken," he said.

The country's president, Nicos Anastasiades, held a half-hour conversation with the Russian president, Vladimir Putin, said to be "a fruitful and constructive discussion on the economic relations between the two countries", he added.

Russia has previously supplied US$2.5bn emergency funding to support the Cypriot government, which was forced to bail out its banks after Greece's debt restructuring last year.

The two countries have a double-taxation agreement, allowing the Cypriot banking sector to be used as a tax shelter by Russian firms.

Liabilities due to companies and individuals outside the euro zone accounted for around a quarter of the Cypriot banking sector's total at the end of January, according to data from the European Central Bank.

Russia's VTB said that the acceptance of the deposit levy would force it to "re-examine its business development strategy in Cyprus" in a statement yesterday.

"Even in the worst case scenario, losses to the bank would be tens of millions of euros," the statement said. "Nevertheless, VTB Group believes that the proposed solution on the deposit levy is unprofessional, dangerous and could threaten the financial stability of the European and the global economy."

The National reported yesterday that Middle Eastern investors were primed to withdraw accounts from Cyprus to outside the euro zone, and had made inquiries to FX firms about shifting accounts.

Europe would have to move carefully in the hours ahead to reassure markets, Steven Saywell, the head of FX strategy at BNP Paribas, said.

"The challenge here for euro-zone officials is to convince markets that this is a special case - that it's not representative of the euro zone as a whole," he said.

"It's a tough job to convince investors especially outside the euro zone… It's exactly because of that risk that encourages me even more so to expect a deal here, and not to expect a miscalculation where the Europeans shoot themselves in the foot and allow contagion to spread."

The levy was originally intended to raise €5.8bn and help the country unlock €10bn in emergency loans from the troika of the IMF, the European Central Bank and the European Commission.

Depositors were to take haircuts because of the relatively small number of bonds issued by Cypriot banks, in a move which circumvented European deposit guarantee schemes.

"Even if a deal is struck, recent developments will tarnish the image of eurozone policymakers," analysts from Capital Economics wrote in a research report. "The fact that policymakers were prepared to risk reigniting the eurozone crisis over a relatively small sum of money is clearly a worry."