Collapse is averted, but fear lingers

Global markets rallied after European leaders struck a last-minute deal to prevent a meltdown in the Cypriot banking system, calming fears of another bout of financial instability in the eurozone.

Global markets rallied after European leaders struck a last-minute deal to prevent a meltdown in the Cypriot banking system, calming fears of another bout of financial instability in the eurozone.

Investors pushed regional sharemarkets higher on Monday and the euro surged by 1¢ to US130.29¢, buoyed by a radical plan to secure a bailout for Cyprus without imposing losses on people with deposits of less than €100,000 ($124,000).

The euro also spiked against the Australian dollar, rising by almost 1¢ to $1.25.

Hours before a deadline that would have triggered a collapse in Cyprus's financial system, leaders agreed to wind down the island's second largest bank and move insured deposits of less than €100,000 to a "good bank".

In return, the country will get an emergency loan of €10 billion from a consortium that includes the International Monetary Fund, the European Union and the European Central Bank.

Under the agreement, Laiki Bank, Cyprus's second biggest, will be split into a "good" and "bad" half and be gradually wound down.

This move will take a hefty toll on bond holders; large deposit holders could lose as much as €4.2 billion. Laiki's "good half" will be merged with the country's biggest lender, Bank of Cyprus. People with uninsured deposits of more than €100,000 in Bank of Cyprus will also face hefty losses, thought to be as much as 40 per cent.

Despite the agreement, the cost to deposit holders is likely to deal another blow to investor confidence in the ailing eurozone.

It comes after shareholders in Spain's Bankia - a key lender in that country's crisis - were told they would be virtually wiped out under a recapitalisation plan announced at the weekend.

Westpac chief currency strategist Robert Rennie said the decision to impose such huge losses on people with uninsured deposits in Cyprus, many of whom are wealthy Russians, could be a worrying precedent.

"It's not been a good weekend for people who have uninsured deposits in the periphery of the European banking system," he said.

"You don't have to be a Russian oligarch to have uninsured deposits in European banks."

International Monetary Fund managing director Christine Lagarde said the deal provided "a comprehensive and credible plan to deal with the current economic challenges in the country. We believe the plan provides a durable and fully financed solution to the underlying problems facing Cyprus and places it on a sustainable path to recovery," she said.

The ASX200 gained 22.9 points, or 0.5 per cent, to close at 4990.2, while the broader All Ordinaries rose by 20.7 points, or 0.4 per cent, to close at 5001.5.

Banks drove the market, with ANZ gaining 28¢ to close at $28.83; National Australia Bank rising by 22¢ ($30.85); Westpac rising by 51¢ ($31.01) and Commonwealth Bank gaining 37¢ ($69).

The loss to uninsured deposit holders is a massive blow to major investors in Bank of Cyprus, which holds the lion's share of Russian deposits.

Westpac warned that Russia had been "hit hard" by the deal. "Watch for any retaliation, especially aimed at Germany, which has been publicly blamed by Russia for leading the push to hurt depositors in order to limit the size of the ESM [European stability mechanism] loan."

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