Cyprus on brink of financial collapse

Cyprus's financial system was on the edge of collapse on Wednesday with local banks now not due to reopen until next week and European authorities warning they could begin withdrawing support for the country within days.

The country's central bank said lenders would remain shut until at least Tuesday amid growing speculation the Mediterranean island could become the first eurozone member to exit the currency bloc.

The Nicosia parliament was debating capital controls to stop deposits flooding out of the country. Such a measure would send shock waves through the single currency, signifying an end to the free movement of capital between member states, a basic principle of the European project.

Christian Clausen, president of the European Banking Federation, said a way had to be found to re-open Cypriot banks. "Everything needs to be solved very quickly. This is a matter of a very few days before it gets too late," Clausen told Reuters. "The issue is how this will impact confidence across Europe."

European Central Bank (ECB) officials were reported to be considering pulling the plug on Cypriot banks unless the country agreed to a new bail-out package.

Jorg Asmussen, the ECB's chief negotiator, warned that Cyprus's decision to reject the terms of a 10 billion euros rescue deal meant it could not guarantee support to domestic lenders for much longer.

"We can provide emergency liquidity only to solvent banks and … the solvency of Cypriot banks cannot be assumed if an aid programme is not agreed on soon, which would allow for a quick recapitalisation of the banking sector," said Asmussen in an interview with a German newspaper.

The threat followed the Cypriot parliament's rejection of a rescue package that would have seen a levy of up to 10% on deposits of more than 100,000 euros.

Senior European politicians have expressed hope a new lifeline can be organised, although some have begun to openly discuss the possibility of Cyprus exiting the euro. Austrian chancellor Werner Faymann said he could not "rule anything out for Cyprus".

German chancellor Angela Merkel said she expected the Nicosia government to come up with a new rescue plan, but insisted it was fair for large depositors in Cypriot banks to face a loss on their savings.

The prolonged closure of banks has led to widespread fears among industry executives that it could undermine confidence in the financial system. Hung Tran, deputy managing director of the Institute of International Finance, the banking industry's main lobbying group, warned that the "symbolism" of the banks' closure was "significant", adding: "The risk is that there will be a deposit flight out of Cyprus."

However, US Federal Reserve chairman Ben Bernanke played down the development's likely impact on the global economy. "Cyprus is a tiny economy," he said. "I don't think these issues, as worrisome as they are and as concerned as we are for the people of Cyprus … I don't think they have a direct implication for the US economy."