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Protesters shout slogans during an anti-bailout rally outside the parliament in Nicosia March 19, 2013. Cypriot lawmakers overwhelmingly rejected a deeply unpopular tax on bank deposits on Tuesday. (YORGOS KARAHALIS/REUTERS)
Protesters shout slogans during an anti-bailout rally outside the parliament in Nicosia March 19, 2013. Cypriot lawmakers overwhelmingly rejected a deeply unpopular tax on bank deposits on Tuesday. (YORGOS KARAHALIS/REUTERS)

Cyprus crisis deepens as bailout rejected Add to ...

The Cypriot parliament’s overwhelming rejection of the euro zone’s bailout plan put the small Mediterranean country on the verge of a full-blown banking crisis as the finance minister scrambled to find fresh funds to buy time.

On Tuesday night in Nicosia, not one lawmaker endorsed the bailout plan, whose central feature was a tax on depositors – the first proposed in any European bailout – that would have hit rich and poor alike. Of the 56 parliamentarians, 36 voted against; there were 19 abstentions and one no-show.

The rejection of the plan is of wide concern even though Cyprus is tiny. Investors fear that potential collapse of the Cypriot banking system and economy could have an outsized effect on the jittery sovereign debt markets and deliver the message that the euro zone is incapable of delivering a bailout that solves more problems than it creates.

The tax’s goal was to reduce the cost of the bailout to about €10-billion by raising €5.8-billion from depositors, a plan that triggered outrage among Cypriots and the Cypriot banks’ foreign customers, many of then Russian. Anti-tax protests in front of the parliament building continued on Tuesday. Some signs, in Italian and Spanish, said “today me, tomorrow you,” a reference to the fear that any future euro zone bailouts could raid bank deposits in other struggling countries.

A prominent Cypriot banker, who did not want to be identified, called the situation “critical” because the bailout was largely designed to stabilize Cyprus’s banks. But he said his bank – one of the country’s Big Three – had serious reservations about the bailout plan because the euro zone finance ministers (known as the Euro Group) wanted the Cypriot banks to sell their Greek divisions quickly.

The Cypriot banks are fairly big players in the Greek banking market, with about €25-billion of assets. The banker said the Euro Group fears that the collapse of the Cypriot banks could wipe out their Greek divisions, spreading contagion to Greece and possibly other struggling countries on the euro zone’s Mediterranean frontier. “This is all about protecting Greece,” he said. “If there were a run on the Cypriot banks in Greece, it could spread.”

But the Cypriot banks have no interest in selling at what would be “fire sale” prices, he said.

Earlier in the day, Cyprus’s president, Nicos Anastasiades, warned of the danger of failing to secure a bailout. In a statement, he said that a bank collapse would destroy thousands of businesses, wipe out depositors because the state lacks the funds to guarantee €30-billion of deposits, trigger massive unemployment and “possible exit from the euro.”

But he knew early in the day that parliamentarians would reject the bailout terms because of the tax on deposits. “They think that is unjust and it’s against the interests of Cyprus at large.”

The government was worried that the European Central Bank would withdraw liquidity provisions for the Greek banks because of the bailout plan’s failure. But the ECB said the provisions would continue.

In a note written before the vote, Holger Schmiedig, chief economist in London for Berenberg Bank, said “Our best guess is that Europe would give Cyprus a brief and final chance to rethink and vote again,” he said.

The vote against the bailout means that the government has to find ways to fill the €5.8-billion hole in the bailout plan. The euro zone finance ministers have said they don’t care where the contribution comes from, as long as it comes. Once it can be accounted for, the euro zone’s bailout fund, together with the International Monetary Fund, would contribute about €10-billion.

Russia is one potential source of bailout funds. Russia lent Cyprus $3.3-billion (U.S.) in 2011 as the Cypriot economy and banking system began to fall apart. On Tuesday, Cypriot finance minister Michael Sarris went to Moscow to seek more financial assistance, but appeared to get no commitment. He was forced to deny reports that he had resigned.

Another plan would see depositors who take a “haircut” on their bank deposit awarded bonds whose income would be linked to the expected future revenue from Cyprus’s national gas discoveries.

The original bailout plan demanded that deposits of less than €100,000 would pay a 6.75 per cent tax, while those over €100,000 would pay 9.9 per cent. A proposal to exempt savings of less than €20,000 from tax was not enough to convince lawmakers to back the bailout plan.

Many Cypriots feel they are in a no-win situation, because placing a higher tax on wealthy depositors would result in a flight of cash from Cypriot banks, bleeding the banks dry.

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