How did Cyprus land in bailout crisis?
02:35 - Source: CNN

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Cyprus, European Union strike deal early Monday on €10 billion bailout

Deal will protect deposits of less than €100,000; larger account holders will be taxed

Popular Bank of Cyprus, one of nation's two largest banks, to be broken up immediately

Eurogroup predicts that Cyprus' public debt will reach 100% of GDP in 2020

CNN  — 

Cyprus has agreed to a €10 billion ($13B) European Union bailout after a frantic weekend of negotiations with European lenders, preventing the collapse of the island nation’s financial sector in a deal that will likely mean huge losses for holders of large deposits at Cyprus’ two biggest banks.

What are the terms of the deal?

Cyprus struck a deal with EU officials on a €10 billion aid package to shore up the country’s banking sector. The plan will protect all deposits of less than €100,000, but is likely to impose a levy or “haircut” for account holders with more than €100,000 at the two biggest banks – the Bank of Cyprus and Popular Bank of Cyprus – according to CNN Money.

Popular Bank will be broken up immediately, and its viable assets will be integrated into the Bank of Cyprus. While the exact percentage of the “haircut” has not yet been determined, the levy on Popular Bank depositors alone will raise about €4.2 billion ($5.5B) towards the bailout deal, while shareholders and bondholders are likely to be wiped out.

CNN MONEY: More on Cyprus’ bailout

As part of the program, Cyprus will also have to raise taxes on capital gains and companies, introduce structural reforms and privatize some state assets. It has also agreed to an independent audit of anti-money laundering efforts in the banking system.

EU officials had originally proposed a package that would have imposed a levy on all bank accounts in order to raise €5.8 billion ($7.5B) toward the deal. Account holders with more than €100,000 ($130,000) would have paid a 9.9% levy and those with smaller deposits 6.75%.

But the Cypriot parliament rejected the bailout offer due to public outrage over the levy, prompting fears of a run on the country’s banks, which have been closed since March 16, and officials went back to the drawing board.

What’s the Russian connection?

Nearly a third of the money in Cyprus’ banks is Russian, and the country’s 10% corporate tax – half that of Russia’s – meant Russian firms had been using it as a tax haven since the early 1990s.

Europe has been going after the Cypriot off-shore banking business model for years and believes wealthy foreigners profiting from the country’s low tax rates should contribute to the deal – though it is unclear at the moment exactly how much money it will cost Russian citizens.

OPINION: Are bailouts a vehicle to kick the weak?

The original proposed levy could have resulted in a €2.3 billion loss for Russian citizens and was described by Russian President Vladimir Putin as an “unfair, unprofessional and dangerous step.”

The country has previously come to Cyprus’ aid with a €2.5 billion loan, according to CNN Money, and EU officials said they hoped Russia would make a contribution to the new rescue effort by extending the term of that loan and/or reducing the interest rate.

What comes next?

Jeroen Dijsselbloem, who chaired the meeting of eurozone finance ministers who hashed out the bailout deal, said a decision on whether to open Cyprus’ banks for the first time in 10 days as scheduled on Tuesday would be made later Monday after consultations with international lenders.

But what is clear is that unlike the first proposed deal, the Cypriot parliament will not have to vote this time around on whether to approve the bank “haircut” for account holders – lawmakers handed that power over to the Central Bank of Cyprus when they approved a series of new measures last week.

CNN MONEY: Tough times ahead for Cyprus

The passage of the bank restructuring laws last week is crucial, as it means politicians do not have to vote to remove money from people’s accounts.

So once the decision is made on precisely how much the levy will be from large deposit holders, that fee will simply be imposed on those bank accounts, and could be up to 20%, according to CNN’s Jim Boulden in Nicosia.

CNN Money’s Mark Thompson reports that the deal will exact a toll on Cyprus’ financial sector and economy – cutting the banking industry in half, costing thousands of jobs and starving the economy of credit, deepening a painful recession.

How is Cyprus coping with this financial limbo?

When the original deposit levy plan was announced, Cypriots rushed to withdraw their savings from ATM machines, and some banks were refusing to release cash, or were putting limits on withdrawals.

The Central Bank of Cyprus extended the country’s March 18 bank holiday, initially saying banks would reopen on March 21. The bank then revised that to say banks would be closed on March 21 and 22 as well as Monday, March 25, an existing bank holiday for Greek Independence Day.

Cypriots carrying “Hands off Cyprus” banners hit the streets throughout last week to vent their fury over the proposed bank levy.

Why is Cyprus facing financial problems?

In a March 16 statement the Eurogroup – an informal body of eurozone finance ministers – said the “current fragile situation of the Cypriot financial sector” was linked to its large size relative to the country’s GDP. Eurogroup President Jeroen Dijsselbloem said Cyprus’ banking sector was more than five times the size of GDP and the group predicted that the island’s public debt would reach 100% of GDP in 2020.

Cyprus’ finance ministry said it needed €10 billion “to cover fiscal needs, the restructuring of the banking system and for the support of the economy in general.”

Are Cyprus’ issues related to the financial crisis in Greece?

We need look no further than the streets of Athens to understand how Cyprus ended up in its current position, according to CNN’s Jim Boulden.

When a struggling Greece was allowed to let some of its private bondholders take a loss, Cypriot banks – which held a lot of bad Greek debt – lost money and needed refinancing. So the big financial institutions like the Bank of Cyprus asked for a bailout from the government, and the government came to the EU in June 2012 saying it needed a bailout in turn.

Talks dragged until last weekend, as Cyprus resisted many of the tough economic measures demanded by potential institutional lenders in return for bailout funds. Boulden said one sticking point was whether Cyprus would have to raise its corporate tax from the EU’s lowest of 10% to 12.5% – equal to Ireland.

Susannah Cullinane, Nick Thompson and CNN Money’s Mark Thompson contributed to this report.