Europe sets Cyprus bailout deadline, banks face cutoff

By Michele Kambas and Lidia Kelly

NICOSIA/MOSCOW | Thu Mar 21, 2013 5:32am EDT

(Reuters) - The European Central Bank gave Cyprus until Monday to raise billions of euros to clinch an international bailout or face losing emergency funds for its crippled banks and inevitable collapse.

The warning came with the island's leaders locked in talks on a "Plan B" to raise 5.8 billion euros demanded by the EU under a 10 billion euro ($13 billion) rescue, after angry lawmakers threw out a tax on deposits as "bank robbery".

Officials said new options discussed on Thursday could include nationalizing pension funds of semi-state companies, issuing an emergency bond linked to future natural gas revenue or a revised bank deposit levy hitting only large investors.

The European Central Bank, which has Cyrpus's banks on a liquidity lifeline, said it had until Monday to get a deal in place, or funds would be cut off.

"Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF program is in place that would ensure the solvency of the concerned banks," it said.

The government has ordered banks to stay closed until Tuesday. The Cypriot stock exchange also suspended trading for the rest of the week.

There were long queues at some bank branches in Nicosia on Thursday as staff replenished cash machines, which have continued to operate while banks have been closed since last week.

In Moscow, Cypriot Finance Minister Michael Sarris said he was discussing possible Russian investments in the island's banks and energy resources to reduce its debt burden, as well as an extension to an existing 2.5-billion-euro Russian loan.

Russian citizens have billions of euros to lose in the island's outsized and now-teetering banking sector.

"The banks are the ultimate objective in any support we get, so it'll either be a direct support to the banks or the support that we get through other sectors will be channeled to the banks," Sarris told Reuters during a second day of talks with his Russian counterpart, Anton Siluanov.

He said Cyprus had no plans to borrow more money from Russia and add to its debt mountain.

Jeroen Dijsselbloem, Dutch head of the group of euro zone finance ministers, said new loans from Russia would not solve the debt issue, and that a revised levy on tax deposits was still on the table.

"I'm not sure that this package is completely gone and failed, because I don't see many alternatives," he told the European Parliament in Brussels.

EU officials believe at least some of the 5.8 billion they are demanding should come from the 68 billion euros in Cypriot banks, 38 billion of which are in the form of big deposits of more than 100,000 euros, mainly from foreigners.

But hitting small bank depositors causes visceral outrage, and the Cypriot government fears that foisting too big a burden onto large depositors would wreck the offshore financial industry that forms much of the country's economy.

Among the other options, nationalizing pension funds of semi-public companies could yield between 2 billion and 3 billion euros. Issuing bonds linked to future natural gas revenue is problematic because pumping any gas is years away.

INSOLVENCY

Doubts about the fate of the small nation of just 1.1 million people has shaken confidence in the single-currency euro zone and raised geopolitical tension between the EU and Russia.

Russian Prime Minister Dmitry Medvedev, who was preparing to meet an EU Commission delegation in Moscow on Thursday, said the bloc had behaved "like a bull in a china shop" and likened its proposals, which would force Russian customers to contribute to the rescue of Cypriot banks, to Soviet-era confiscations.

Tuesday's parliamentary vote marked a stunning rejection of the kind of strict austerity accepted over the past three years by crisis-hit Greece, Portugal, Ireland, Spain and Italy.

But the European Central Bank kept the pressure on, warning that it would have to pull the plug on Cyprus unless the country, one of the smallest of the 17 members of the euro zone, took a bailout quickly.

"I cannot rule out a Cyprus insolvency," Austrian Finance Minister Maria Fekter said in an interview with the Austrian newspaper Oesterreich. "A euro exit would not achieve anything. Cyprus must act now."

With Cypriot Energy Minister George Lakkotrypis also in Moscow, officially for a tourism exhibition, speculation was rife that access to untapped offshore gas reserves could be on the table as part of a deal for Russian aid.

Cyprus is a haven for billions of euros squirreled abroad by Russian businesses and individuals - one of the reasons why Germany and other northern euro zone states are reluctant to bail it out without a contribution from bank depositors.

The island's banking sector was hollowed out by its exposure to bigger neighbor Greece.

The proposed levy on deposits would have taken nearly 10 percent from accounts over 100,000 euros. Smaller accounts would also have been hit, although the government proposed softening the blow to spare savers with less than 20,000 euros.

Cypriots were enraged at the proposal to tax accounts with less than 100,000 euros, which are meant to be protected by state guarantees across the European Union.

European officials say the Cypriot government could have protected small savers if it imposed a higher tax on big deposits, but it refused to do so to protect the rich foreign clients of its offshore banking business.

EU leaders are growing increasingly exasperated, while the threat of bankruptcy for a member of the euro zone, however small, raises fears for confidence in the currency.

"There is no obligation to accept help," said Polish Foreign Minister Radoslaw Sikorski, whose country does not use the euro. "Cyprus has the possibility of living with its own mistakes."

(Additional reporting by Karolina Tagaris in Nicosia, Georgina Prodhan in Vienna and Darya Korsunskaya in Moscow; Writing by Matt Robinson; Editing by Peter Graff)