Cyprus makes frantic effort to prevent run on its banks

Euro Toliet Roll

Cyprus is embarking on emergency efforts to restructure its second largest bank and considering new rules to stop money flooding out of the country's banks when they reopen next week after being shut for ten days.

As eurozone finance ministers held an unscheduled conference call at which they agreed to discuss a "plan B" for Cyprus, the Nicosia government submitted a bill to its parliament that could allow its finance minister or central bank governor to impose capital controls in cases of "public order or security".

The central bank governor Panicos Demetriades set out measures to restructure the second-largest bank, Laiki, and protect savers with deposits up to €100,000, the level of guarantee on bank savings across the EU.

"By establishing this legal framework, resolution measures will be imposed on Popular Bank (Laiki) so that it will be in a position to continue to offer banking services to its clients next Tuesday," when banks are due to reopen, Demetriades told reporters.

Under a new plan being developed, Cyprus also appears to wants to create an "investment solidarity fund" to raise fresh cash to help fund its €17bn bailout – the same size of its economy, which is weighed down by a banking sector eight times the size of the economy and containing up to $19bn of deposits from wealthy Russians.

The European Central Bank had piled pressure on the Cyprus government earlier in the day, warning that it would halt all emergency funding to the country's collapsing banks unless a €17bn bailout deal was agreed with Nicosia's eurozone creditors by Monday. The threat of the ECB withdrawing support appeared to exacerbate the situation in Cyprus, where queues formed at ATMs despite government efforts to dispel what officials quickly described as "groundless rumour" about over what the rescue package would entail.

Laiki announced that it had scaled back withdrawals to €260 a day – from €800 - and its spokeswoman Aliki Sylianou was forced to deny widespread reports it had been closed. Cypriots were far from convinced, however, with huge queues forming outside local Laiki branches.

At branches in Nicosia, the divided capital, Cypriots queued for hours in the hope of withdrawing cash with lines frequently moving at a snail's pace because of the inability of cash machines to dispense more than €40 at a time. "I've had to use my card ten times to get €400," said Maria Gika, stuffing wads of cash into the pockets of her jeans before Laiki announced the €260 euro limit late on Thursday. "I'm entitled to withdraw €800 a day. It's disgusting that I'm unable to access my own money."

Under the latest plan being promised, Laiki would be split into a good and bad bank where, according to reports, the larger savings accounts would be placed and face losses of up to 40%.

The original deal, agreed in the early hours of Saturday morning, involved €5.8bn being taken from bank accounts through a tax at a rate of 6.75% on deposits under €100,000 and 9.99% on any accounts larger than that.

The move had caused outrage as the levy was imposed on accounts smaller than the €100,000 guarantee, although reports that the unpopular levy was being dropped prompted Russia's prime minister, Dmitry Medvedev, to interrupt a conference in Moscow to read the news from his iPad. The announcement was met with applause and shouts of "hurrah!" from delegates.

There are concerns that Russians will race to move their money once the banks reopen. A copy of a bill presented to the Cypriot parliament was obtained by Reuters, which indicated that measures were being put in place to stop billions of euros leaving the country.

"The purpose of this law is, in case of an emergency for purposes of public order or security, to assign powers to the (finance) minister, or the (Central Bank) governor to take and impose temporary restrictive measures, including restrictions on capital controls," the bill said.

The eurogroup of finance ministers issued a statement after their conference call in which they agreed to discuss new proposals – stressing the importance of maintaining the €100,000 guarantee.

Following the conference call of eurozone finance ministers on Thursday evening, the governments backed away from the agreement they reached with Cyprus at the weekend, stating that there should be no raid on savings of Cyprus bank depositors holding less than €100,000.

The ministers called on the Cypriot government to come up with an alternative way of raising the €5.8bn following the collapse of the weekend agreement and said they were prepared to discuss it, but that the "troika" of European Commission, European Central Bank, and International Monetary Fund official would need to scrutinise and endorse any new bailout scheme.

It was not clear what would happen if these procedures extended beyond the Cypriot banks' emergency financing deadline set for Monday by the ECB.

Amid continuing recriminations about who had designed a plan that would involve hitting savers Jeroen Dijsselbloem, the Dutch finance minister, who chairs the committee of eurozone finance ministers, accepted responsibility for the botched agreement. Dijsselbloem said that the situation in Cyprus represented a "systemic risk" to the euro and spoke of the dangers of contagion spreading elsewhere, putting himself at odds with Berlin which has regularly played down the perceived risks from such a small economy as Cyprus.

Minutes of a meeting of eurozone officials on Wednesday, obtained by Reuters suggested that it was mulling the possibility of a banking collapse on the island.

The German government official taking part in the call demanded information on capital flowing out of Cyprus to Britain and Russia, while there was also talk of Cyprus being forced to quit the euro. Cyprus's finance minister, Michael Sarris, and his Russian counterpart held talks for a third day about providing assistance to Cyprus, although analysts played down ideas that Russia's state owned gas giant Gazprom is likely to be interested in operating Cypriot gas fields.

Powered by article was written by Helena Smith in Nicosia, Ian Traynor in Brussels, Howard Amos in Moscow, Jill Treanor, for The Guardian on Thursday 21st March 2013 21.45 Europe/London © Guardian News and Media Limited 2010