The European Central Bank gave a new ultimatum to Cyprus to recapitalise its financial sector, as euro-zone officials, the IMF and Russia attempted to thrash out a deal to rescue the country's banks.
As queues of savers lined up to withdraw deposits from ATMs, the ECB said it would maintain its current level of emergency funding until Monday.
"Thereafter, emergency liquidity assistance [ELA] could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks," the ECB said.
The Cypriot central bank governor Panicos Demetriades said he expected that by Monday a support programme for the Cypriot economy would be in place, with banks closed until at least Tuesday.
"Following a proposal by the president of the republic a consensus was reached and a unanimous decision was taken for the setting up of an investment solidarity fund," the Cypriot government said. "The proposal is currently undergoing legal and technical processing by the law office of the republic."
Cyprus had previously attempted to raise €5.8 billion (Dh27.54bn) through a levy on depositors in an effort to unlock €10bn in funding from the so-called troika of the European Commission, the European Central Bank and the IMF.
The measure would have taxed all depositors at a rate of 6.75 per cent, a levy that would have increased to 9.9 per cent for those with deposits above €100,000.
The move, which would have circumvented European deposit guarantee schemes, was struck down by the Cypriot parliament on Tuesday, sparking crisis talks among political parties to put forward a "plan B". The situation remained "a mess" and had only become worse with Russian involvement, wrote Steen Jakobsen, the chief economist at Saxo Bank.
"The longer the bank holiday, the more likely Cypriot banks will see a bank run - so the time dimension works both ways, needing time to find a solution but also increasing the ultimate odds of people wanting to take their money out when the banks finally open," he said.
"I personally do not believe any solution to Cyprus will create enough credibility to stop this."
Legislators said yesterday that they had ruled out any kind of levy on individual bank accounts.
The Cypriot finance minister Michalis Sarris was quoted by Russia's official RIA news agency saying that the Cypriot delegation was negotiating further financial aid from Russia in return for stakes in the Mediterranean nation's banks and gas projects.
Russia, which previously provided a US$2.5bn (Dh9.18bn) loan to Cyprus, currently has a double-taxation agreement with the island allowing it to be used as a tax shelter.
This has led to Russia becoming a major source of deposits in the Cypriot banking system and heavily exposed to the island's banking sector.
"It seems to me there is a potential deal structured so the loan is turned to equity over time, in a way that would be compatible with the IMF's requirements," said Jacob Nell, an economist at Morgan Stanley in Moscow.
Elsewhere in the euro zone, the Stoxx 600 index of European equities fell 0.5 per cent in midday trading and the euro fell 0.1 per cent against the dollar to $1.2916, weighed on by lower-than-expected industrial data.
The euro zone composite purchasing manager's index fell to a four-month low of 46.5, with readings from Germany and France falling far below estimates. A PMI reading of more than 50 signals expansion; below 50 signals contraction.
The reading disappointed analysts who were given fresh signs that the euro-zone economy will slump further into recession this year.
"The latest PMI numbers show that even before the recent developments in Italy and Cyprus, the euro-zone economy may have been losing momentum and supports our view that the consensus forecasts for euro-zone GDP growth this year is too optimistic," analysts from Capital Economics wrote in a research note.
* With Reuters
