Monday or else! ECB delivers ultimatum on Cyprus

03/21/2013 2:10 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The European Central Bank has given Cyprus an ultimatum: Come up with a plan that can secure approval from the EuroZone countries and the International Monetary Fund by Monday or the central bank will cut off emergency funds to Cypriot banks. At a minimum that would lead to the failure of at least two insolvent banks in Cyprus. At worst it would lead to a bank run that would take down the country’s entire banking system.

The government’s most recent plan is to set up a “national solidarity fund” with assets that might include government property, pension fund assets, maybe even property owned by the Church of Cyprus, as well as contributions from citizens and businesses in the country. The assets in that fund could then be used to secure loans that would replace the $5.8 billion euros for the bailout plan that were to have come from the now-dead levy on the accounts of bank depositors.

No one is sure if that plan will win approval in parliament or if it is acceptable to the IMF and the EuroZone countries. But Cyprus has descended into something like political paralysis. Cyprus decided not to participate in last night’s conference call with members of the European Working Group. That left this collection of finance and treasury officials plus representatives from the European Central Bank in the awkward position of having to make plans for ending the crisis without being able to consult with representatives of the Cypriot government.

It’s clear why the European Central Bank has issued its ultimatum: without a deal in place with EuroZone countries and the IMF, the central bank would be at risk of losing any money that it lends to Cypriot banks in the advent of a bank run. The ECB has extended 9 billion euros in liquidity to Cypriot banks. With total bank deposits of something like 60 billion euros (about 20 billion euros belong to Russian depositors) the 9 billion in liquidity provided so far is well short of what would be needed in case of a bank run. If the central bank extended more liquidity to cover withdrawals, the central bank could wind up losing that money if Cypriot banks collapsed anyway.

What’s much less clear is the exact extent of the European Central Bank’s ultimatum. Would the bank refuse emergency loans to all banks in Cyprus or just to the most troubled banks, such as Laiki Bank, the second largest in Cyprus, that are insolvent? Rumors that Laiki would close or be reorganized into a good and a bad bank are rife in Cyprus today. The bank has imposed a 260-euro limit for ATM withdrawals.

Banks are scheduled to remain closed for at least four more days.

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