The Central bank of Cyprus ordered all its banks to freeze accounts for two days while the government imposes a one time levy on depositors that will cost them up to 10% of their deposits.

The shock news broke on Sunday and the Cypriot parliament is due to vote on the measure today Monday March 18. The unprecedented grab of deposits has been widely criticised: the Financial Times ran a scathing op-ed that points out the decision to simply take 9.9% of deposits over €100,000 and 6.75% of those below breaks the fundamental basis of trust embodied in the deposit insurance scheme and hence the banking sector in general that is supposed to protect small depositors irrespective of how much trouble their banks get into.

The charge is part of a €10bn bailout deal thrashed out over the weekend in Berlin between the EU finance ministers and the Cypriot government. The levy on deposits has reduced the total bail out from €17bn initially proposed.

Cypriot President Nicos Anastasiades said he had to choose between the "catastrophic scenario of disorderly bankruptcy or the scenario of a painful but controlled management of the crisis". He said those who keep deposits in Cypriot banks for two years will get half of the value of the levy back I the form of bonds backed by future income from exploiting Cypruss natural gas deposits. Cypriot nationals will also get shares in the banks to the equivalent amount of the charge, according to some reports.

The big unknown is just how badly the move will hurt the Russian banking sector. Cyprus is a major offshore financial haven for the Russian economy, but while many numbers have been bandied about no knows for sure how much money Russian banks and business hold in Cypriot accounts.

As of January, €43bn of the €68bn in Cypriot bank deposits was held by domestic residents, according to the countrys central bank. More than €20bn officially came from the rest of the world, with the bulk of that believed to be from Russia. However, many Russian companies are domiciled in Cyprus and so technically counted as domestic and hence the amount of money Russians hold in banks there are is probably even more than €20bn. Experts say that the total amount of Russian money on deposit could be anywhere between $8bn and $35bn.

The vote in parliament today could see the terms softened. Anastasiades told the BBC that he is seeking a better deal for depositors.

Officials involved in Sunday nights talks told the FT that levys rates have not been set in stone yet and the higher rate could increase to as much as 12.5% while the smaller deposits could be reduced to 3.5%. Other EU officials have called for all the burden to be put on the big depositors and the lower rate cut to zero.

Banks were closed on Monday and may not open Tuesday either while the government faces the crisis.

Todays vote may scupper the deal as several lawmakers from the Democratic party, the junior partner in the governing coalition, have threatened to vote against it. The government controls only 28 of 56 seats in the chamber and is seeking backing from two deputies from a small pro-European party. Anastasiades appealed to Cypriots to accept the levy as the least painful solution.

The ECB is putting a lot of pressure on the island state and warned that the countrys two biggest banks, Bank of Cyprus and Laiki Marfin, would go bust. If Laiki fails then it would cost the government €30bn, according to local exports, and spark a systemic meltdown. Moreover, everyone is afraid a collapse of the Cypriot system would spark contagion and infect the Spanish and Italian markets.

Source: bne