Cyprus will hit large depositors with 40pc losses to save banks

Cyprus will inflict losses of up to 40% on large depositors but guarantee all deposits up to 100,000 euros in a plan to restructure its biggest banks and prevent the island's economic collapse.

Following a run on the Laiki bank on Thursday, the Cypriot parliament has passed laws enacting strict capital controls for when banks open next Tuesday, restricting the movement of funds for up to 60,000 British expatriates with accounts in Cyprus.

Finance ministers for the 17 eurozone countries said negotiations would begin on the proposals to restructure and freeze all assets held in the Popular Bank, known in Greek as Laiki, and the Bank of Cyprus.

Panicos Demetriades, the governor of the central bank of Cyprus, said "urgent" legislation was needed for the "reorganisation and recovery of the Cypriot banking system" in a crisis that threatened to spark a run on banks and wipe out 1.7 billion pounds in savings held by Britons: "The banking system needs restructuring otherwise it will go bankrupt and it needs to be done immediately."

"This consolidation process will prevent the risk of bank failures and protect in their entirety all insured deposits up to the amount of euros 100,000 euros. It also creates conditions for the recovery of the banking system and guarantees jobs."

Cyprus will divide Laiki into two entities. One will contain all insured deposits of under euros 100,000 and the other will be a "bad bank" with larger deposits, many of them Russian, subject to an asset recovery programme and substantial losses.

Last night Cypriots queued to withdraw cash from the Laiki bank, the country's second largest, after the European Central Bank warned it would cut off funds on Monday unless there was agreement on an international bail-out.

To prevent the bank's collapse a cash limit of 260 euros a day was imposed as panic was fuelled by an angry demonstration by Laiki staff outside the Cypriot parliament. The restructuring means 10,000 jobs are at risk.

Eurozone officials warned Cyprus that unless it agreed to restructure its bank, hitting investors with deposits of more than 100,000 euros with a substantial haircut, the ECB would pull the plug by withdrawing "emergency liquidity assistance" to Cypriot banks, forcing it out of the euro.

"If the financial sector collapses, then they simply have to face a very significant devaluation and faced with that situation, they would have no other way but to start having their own currency," said a senior EU official.

Before clearing a euros 10bn EU-IMF bail-out and continued liquidity support for banks in Cyprus, eurozone finance ministers will seek assurance that the Laiki restructuring reduces Cypriot bank debt by euros 5.8bn.

A Cypriot plan for a new state investment fund to recapitalise banks will be backed by nationalised pension funds, church property and as yet untapped oil and gas reserves.

It will be scrutinised by the eurozone ahead of parliamentary votes on nine emergency bills to end the Cypriot crisis.

This latest eurozone crisis was triggered at the weekend when the eurozone imposed a levy on all Cypriot bank accounts, including previously guaranteed deposits under 100,000 euros. The levy was rejected by the Cypriot parliament on Monday, triggering turmoil in the eurozone.

John Cridland, the director-general of the CBI, warned that "the ill-thought-out 'stability levy' on bank deposits has created a real mess. While technically a tax, it undermined the confidence of ordinary depositors in the safety of their savings," he said.

Meanwhile, S&P cut Cyprus' credit rating to CCC from CCC+.