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The Cyprus government is working with EU officials on contingency plans to keep the island’s teetering financial system afloat in case of a crippling outflow of deposits when the island’s banks reopen for business after an extended bank holiday.

Shayne Heffernan said today “Cyprus has shown us what the EU s prepared to do to solve the debt issue, they are prepared to default on loans and steal the assets of private citizens. Anyone keeping anything in the EU now is doing so at great risk. Institutions, Funds and large corporations will now cut their EU assets and spark a total deleveraging of the EU Banking system, the is the black swan event that began in Greece when the painted a default on debt as a deal”

Banks will remain closed through Wednesday, following the decision Saturday morning by eurozone finance ministers that a tax should be imposed on all bank depositors on the island as a condition for receiving a EUR 10-B ($12.9-B) bailout. Imposing costs on bank depositors broke a taboo in the eurozone’s handling of its three-year financial crisis.

In an address to a parliamentary committee, central bank Gov. Panicos Demetriades said banks could stand to lose as much as 10% or about EUR 7.5-B ($9.6-B) of their deposits within days of reopening.

“Every day that banks are closed is a wound,” he said, urging the Cypriot deputies to pass a new tax-deposit plan and secure the rescue from the euro zone and the International Monetary Fund.
Officials said it was likely that the banks would remain closed, at least until next Tuesday, following a national holiday on Monday. That extended closure appeared more likely after the Cypriot parliament rejected a bill Tuesday evening to put the bank tax into law. Further votes are expected.

Ewald Nowotny, a member of the governing council of the European Central Bank, said Tuesday that the ECB remains ready to help the Cypriot banks with extra liquidity when the banks finally reopen.
“No decisions have been taken because we do not know the final results of the discussions in Cyprus, but given the present legal background, the ECB will be prepared to fulfill this task of a lender of last resort,” he said.

After the no-Vote, the European Central Bank issued a statement reaffirming its commitment to provide liquidity to banks “as needed within the existing rules.”

The statement implied that banks would be helped if the rescue package was agreed by parliament. But if the rescue deal was rejected, the banks would be insolvent and the ECB would withdraw its support.
The contingency measures, described by 3 European officials, may not need to be implemented if the deposit outflow looks containable. The plan includes imposing limits on daily withdrawals from bank accounts, capping the amount of money that can be electronically taken out of the country and making these transactions slower to clear; and introducing border checks to cap the amount of cash leaving the country.

One official also said the IMF had been tasked with developing a plan to merge the country’s two biggest banks–Laiki Bank (CP:LI) and Bank of Cyprus (CP:BOCY) putting their healthy assets into a smaller entity and the non-performing assets into a “Bad Bank,” which would not do any new business.

A spokeswoman for the IMF had no comment. EU officials have repeated that the goal is to shrink the island’s banking sector over time.

After the finance ministers’ meeting Saturday morning, Jorg Asmussen, the German member of the ECB’s executive board, said the Cypriot central bank and treasury have “prepared a contingency action plan, they are monitoring deposit flows, even on an intra-daily basis and will take the necessary actions if appropriate.”
The officials said neighboring countries had been instructed to be ready to fly EUR notes into Cyprus should the need arise, but one official said this had not yet happened.

In a sign of the tense mood about cash reserves, the UK Ministry of Defence said Tuesday a British Royal Air Force flight had been sent to take EUR 1-M to Cyprus as a “contingency measure” for UK military personnel stationed on the island. A spokesman said the cash was there “in the event that cash machines and debit cards stop working completely.”

He said the ministry was “proactively approaching personnel to ask if they want their March, and future months’ salaries paid into UK bank accounts, rather than Cypriot accounts.”

The officials said such planning should not be a surprise: “This is exactly what is to be expected and exactly what was in place for Greece last Summer,” one official said, referring to the critical Greek elections in June 2012 during which depositors were removing large sums of cash out of Greek banks, spooked by the prospect of a Euro exit.

Spokesmen for the European Commission and the European Central Bank declined to comment on the contingency plans, and ECB officials have said it is a matter for the Cyprus government.

A spokesperson for the Central Bank of Cyprus did not respond to calls for comment.

Analysts said the direct impact of Cyprus’s problems on the rest of Europe’s banks would be small, given their small size and the fact that few other banks would have lines of credit outstanding to the island’s banks.
Asked about the risks to Europe’s banking system posed by the bailout deal in Cyprus, Mr. Nowotny, Austria’s central bank governor, said “I think this is something that has to be taken very seriously and therefore full and frank information is very necessary.”

But he said contagion to other troubled eurozone countries is unlikely, calling Cyprus a “very special case.”

He pointed to banking assets on the island that amount to around 670% of the country’s GDP.

The Banking model in Italy for instance is in a much safer situation: total banking assets of Italy are 290% of GDP; in Spain it is 380%, about the European average.

The banking systems of these countries cannot be compared,” Mr. Nowotny said. He said that, “from a point of fairness it would be preferable to have an exclusion of small savings, but there is a need to achieve this number of EUR 5.8-B that has been agreed as the contribution of Cyprus,” said Mr. Nowotny.