Cyprus parliament on Friday approved legislation that could part-nationalise the Popular Bank, its second-largest lender and heavily exposed to Greek debt, in a bond-for-equity swap if attempts to raise 1.8 bln euros privately fail by a mid-year deadline.
The law, approved unanimously by MPs in an all-night debate, said the state would be underwriter for a rights issue by the bank, potentially avoiding the need to seek a bailout for the institution, which needs to replenish its core tier 1 capital by June 30.
Any unallocated shares from a share offer to existing shareholders or via a private placement, will be assumed by the state, which would offer sovereign bonds for its shareholding.
The amount, equivalent to about 10% of Cyprus GDP, forms the bulk of a 1.97 bln euro ($2.5 bln) capital shortfall identified by the European Banking Authority.
Popular was hit heavily by a writedown on its Greek sovereign bond holdings. It reported record losses of 2.8 bln euros in its full-year results for 2011, mainly on the back of a 76% writedown in the value of some 3 bln euros in Greek debt.
The capital shortfall of the bank is a predicament for Cyprus, the euro zone's third smallest economy, due to its own limited funding options.
Fiscal slippage and exposure of its banking system to Greece has meant the island has been shut out of international capital markets for a year. Without approval of the legislation, its cash-strapped government could have potentially faced the need to resort either to bilateral lending, or a bailout to aid the bank.
Asked whether the need to seek a bailout had been avoided, Finance Minister Vassos Shiarly told reporters: "This gives us the ability to examine other options and we will work in the time ahead to examine every option possible to avoid the (support) mechanism."
Wary of the experience of Greece and keen to maintain its coveted low-tax status for businesses, Cyprus has done its utmost to avoid turning to its EU partners for any financial aid. It received a 2.5 bln euro bilateral loan from Russia in late 2011, disbursed in three tranches from December 2011 to April 2012.
State underwriting of Popular will have an immediate impact, with the government appointing five of the bank's 13 directors. Should it acquire a shareholding, the state will be entitled to appoint the majority of its directors, who will have veto powers.
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