The Cypriot financial crisis is dangerously close to a boiling point as depositors scramble to withdraw cash amid a warning from European monetary authorities that they will pull emergency funding from the country's banks if a bailout deal is not struck by Monday.
Underscoring the depth of the troubles, the finance ministers of the euro zone spoke by phone and said they were ready to "draft a new proposal" for a bailout.
Customers of Popular Bank queued at ATMs Thursday after rumours swept across the country that the bank was collapsing, escalating the crisis to the point that the membership of Cyprus in the euro zone came into question.
The Cypriot central bank denied the rumours but confirmed that wind-down measures were being prepared to avoid a blow-up.
"By establishing this legal framework, resolution measures will be imposed on Popular Bank so that it will be in a position to continue to offer banking services next Tuesday [when all banks are to reopen]," central bank Governor Panicos Demetriades told reporters. "Otherwise, the Popular Bank will be led to immediate bankruptcy and termination of its operations with catastrophic consequences for the workers and depositors, our banking system and the country's economy."
He said deposit of less than €100,000 ($132,000) would be insured, implying deposits above that amount might be partly lost. To cope with high demand for cash, Popular Bank earlier Thursday imposed a €260 limit on cash withdrawals.
A senior Cypriot bank director, who did not want to be named, said such a plan would see Popular divided into a "good bank and a bad bank," with the best assets probably going to rival Bank of Cyprus and the poor loans into a portfolio that would be wound down. Both banks are unloading their Greek businesses.
The blow to Popular Bank, the country's second-largest lender, came only hours after the European Central Bank said it would suspend emergency assistance to the Cypriot banks on Monday unless a rescue is negotiated with the European Union and the International Monetary Fund.
The threat puts enormous pressure on the Cypriot government to devise a new bailout in the next couple of days or face the eradication of its banking system. If that were to happen, the country's exit from the euro zone would go from unthinkable to possible, perhaps probable.
"Should Cyprus refuse to blink, I believe the ECB will carry out the threat," said Marco Annunziata, chief economist of General Electric Co. "At that point, Cyprus might face a full-fledged banking crisis and be forced to leave the euro zone … I think the economic and social consequences for Cyprus would be disastrous."
Popular Bank, which was largely nationalized last year after losing fortunes on its portfolio of nearly worthless Greek bonds, and Bank of Cyprus exist at the mercy of the ECB's emergency liquidity assistance, or ELA. By the end of January, the banks had taken about €9.1-billion in ELA assistance.
In a statement Thursday, the ECB said its governing council had "decided to maintain the current level of Emergency Liquidity Assistance until Monday, 25 March 2013." It added that after that date, ELA "could be considered if an EU/IMF program is in place that would ensure the solvency of the concerned banks."
Cyprus's banks have been closed since last Saturday. They were to reopen today, but are now to remain shuttered until Tuesday as the government tries to hammer out a revised bailout plan.
The previous plan, whose centrepiece was a tax on bank deposits that would have raised €5.8-billion, was overwhelmingly rejected in a parliamentary vote Tuesday night. The EU and the IMF have agreed to contribute €10-billion to the bailout as long as Cyprus contributes €5.8-billion, though it is not insisting it come from a deposit tax.
Reacting to the rejection, the finance ministers of the 17-member euro zone, known as the Eurogroup, said they were ready to continue negotiations toward a deal while "respecting the parameters defined earlier." They also agreed on guaranteeing deposits below the €100,000 level.
As news of the ECB's ultimatum rippled through the country, Cypriots lined up at ATMs to withdraw whatever money they could. Not all machines had enough banknotes to meet demand. In Nicosia, stores were largely empty as Cypriots tried to conserve cash. For those still shopping, credit cards were the preferred form of payment.
Even if the banking system is propped up, there are serious doubts that the banks will remain viable.
On Thursday, the government appeared to have given up on reviving the deposit tax, which would have shaved 6.75 per cent off deposits under €100,000 and 9.9 per cent of those over that. The proposed tax – unprecedented among European bailouts – enraged Cypriots.
"We didn't discuss a [deposit] haircut and we are not reverting to it," parliamentary house speaker Yiannakis Omirou told reporters.
The new idea, he said, is to create a "solidarity fund" that would bundle state assets to back an emergency bond issue.