Big-ticket savers at the Bank of Cyprus may be forced to accept losses on their deposits of more than 70 per cent to keep the stricken bank afloat, bankers briefed on the negotiations said on Friday.
The more sizeable haircut, coming after the imposition of tough capital controls, is perhaps the most profound reminder of the financial punishment being visited upon this small island economy as it struggles to comply with the conditions Europe is demanding before it gets a desperately needed €10 billion ($12.3 billion) loan.
Europe has demanded that large depositors in the country's two largest banks - Bank of Cyprus and Laiki Bank - accept losses in order to pay for the bailout.
Over the past week, government officials have been quoted as saying that depositor losses would not exceed 40 per cent - even though bankers and lawyers involved in the negotiations have been warning that the final figure would need to be higher if the bank was to re-emerge as a viable entity.
Under the terms of the transaction, large depositors would have 77.5 per cent of their savings turned into different forms of equity, with the rest remaining as a frozen, non-interest-bearing deposit they would be able to access in the future.
If the bank does well, depositors would be able to sell their stock. But even if the bank were to thrive on the back of a quickly recovering economy, a long shot in the opinion of most economists, the loss is likely to exceed 60 per cent and could well be much more than that.
Lawyers and bankers who have analysed the transaction believe the ultimate loss to the depositor could be anywhere between 60 and 77.5 per cent.
The deal has not been officially announced and, given the political sensitivities, there could be further changes. But news of the terms is already rocketing through Cyprus.
How much of a loss uninsured depositors with accounts of more than €100,000 at the bank would have to bear has become a hotly disputed topic, pitting Cyprus' creditors - the European Commission, the European Central Bank and in particular the International Monetary Fund - known widely as the troika, against the Cyprus government.
Given that the country's $US18 billion economy was going to enter a tailspin following the controversial move to impose capital controls and freeze bank deposits equal to one-half the size of the country's economic output, it has become clear that the bank would need a much larger capital cushion to survive.
Projections of a 3 per cent economic slump, once seen as a worst case, now seem wildly optimistic, with most economists expecting a plunge between 5 and 10 per cent this year.
While many of the Bank of Cyprus' largest depositors are wealthy Russians, numerous Cypriot businesses and wealthy individuals also had significant amounts of capital in the bank. Economists believe that wiping out such large savings will be devastating — not just on the economy but on Cyprus' future as a centre for financial services.