(Moneywatch) One of Cyprus' largest banks has capped withdrawals following the European Central Bank's threat to cut off emergency funding to the island nation on Monday unless a bailout plan is approved. The two sides are now in a financial game of chicken, with both hoping the other blinks first before a spectacular crash can take place.
At issue is a $12.94 billion bailout plan of the nation's banks that would require depositors to contribute an additional $7.5 billion to finance the rescue. Under the plan, all accounts in Cypriot banks with less than $129,370 would be hit with a 6.75 percent fee, which negotiators refer to as a tax; for those with more than that, the fee would be 9.9 percent of the amount on deposit.
The fee on depositors raised the ire of the population and on Tuesday the Cypriot Parliament unanimously rejected the plan. It is not only Cypriots who are concerned about this. Mark J. Grant of Southwest Capital is one of many analysts who have questioned the ECB's decision.
"It is not the banking system in Cyprus that they are asking to pay," Grant said in a note to investors. "It is people's bank accounts. It is not a tax but an expropriation of money that belongs to individuals and corporations. ... The demands are not being made on the banks but on the depositors."
Since Tuesday the government has been scrambling to find another way to pay for its share. The plan currently under discussion in Parliament include restructuring Cyprus' troubled banks, some form of Russian help, dipping into pension funds and taking up an offer from Cyprus' wealthy Orthodox church to contribute. Some form of tax on bank deposits is also possible. ECB officials oppose this deal because it would increase the nation's debt load.
Cyprus' finance minister has been in Moscow trying to arrange a deal with the Kremlin. Russian depositors make up a substantial amount of the funds in the island nation's banks. Critics say this is because the nation's lax banking regulations make it easy to launder money.
Today, queues of 40 to 50 people formed at the ATMs of Cyprus Popular Bank, or Laiki, which responded by capping daily withdrawals at $340 per person, down from an earlier limit of $906. Although ATMs have been functioning, many often run out of cash.
"We need cash. We have families, children, grandchildren and expenses, and the banks have been closed since Saturday," said Andri Olympiou after withdrawing money from a Laiki branch in Nicosia, the capital.
If neither side blinks by Monday it could mean the collapse of the nation's banking system, a government default and possibly Cyprus' exit from the EU. However the history of Europe's financial crisis shows that deadlines and ultimatums are seldom as fixed as they seem. Many observers believe this could be building up to yet another kick-the-can-down-the-road moment.
According to analysts at IHS Capital, "Russian intervention is unlikely to be forthcoming and with German and Cypriot positions likely to become more entrenched, the possibility of a stop-gap solution intended to buy time until after Germany's federal parliamentary election in September appears probable."
Although Cyprus would likely lose the most if this came to pass, the ECB also has to worry about the impact on the rest of the EU. A survey taken before the Cyprus crisis and released today suggests the eurozone may have seen its economy contract for the sixth consecutive quarter.
The Associated Press contributed to this report