WRAPUP 7-EU gives Cyprus bailout ultimatum, risks euro exit
* ECB says to cut off bank funds without bailout deal by Monday
* President, party leaders agree "solidarity fund" to securitise assets
* Finance minister discussing banking, energy cooperation with Russia
* Eurogroup chairman says Russia won't lend Cyprus more
NICOSIA/FRANKFURT, March 21 (Reuters) - The European Union gave Cyprus till Monday to raise the billions of euros it needs to clinch an international bailout or face the collapse of its financial system and likely exit from the euro currency zone.
In stark twin warnings on Thursday, the European Central Bank said it would cut off liquidity to Cypriot banks and a senior EU official made clear to Reuters that the bloc was ready to see the bankrupt island banished from the euro in the belief it could then contain damage to the wider European economy.
The ECB ultimatum came as the island's leaders struggled to craft a "Plan B" to raise the 5.8-billion euro contribution demanded by the EU in return for a 10-billion euro ($13-billion) bailout from the EU and International Monetary Fund; angry Cypriot lawmakers threw out a tax on deposits as "bank robbery".
The government said party leaders had agreed to create a "solidarity fund" that would bundle state assets as the basis for an emergency bond issue, but parliament speaker Yiannakis Omirou insisted a revised levy on larger bank deposits, many of them held by Russians, was not on the table.
The European Central Bank, which has kept Cyprus's banks operating with a liquidity lifeline, said the government had until Monday to get a deal in place, or funds would be cut off.
"Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks," it said.
In Brussels, a senior European Union official told Reuters that would mean Cyprus's biggest banks would be wound up, wiping out the large deposits it has sought to protect, and probably forcing the country to abandon 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," the EU official said.
Cyprus's banking system, where massive Russian deposits give Moscow a distinct interest, has been brought close to collapse by its exposure to Greece, the epicentre of the euro zone debt crisis. But until this week, the expectation in Brussels and on financial markets had been that the appointment of a new Cypriot government in February would smooth the path to a bailout deal.
Cyprus's central bank governor said he expected to clinch a financial support package by Monday. He did not say how.
The government has ordered banks to stay closed until Tuesday. The stock exchange also suspended trading for the rest of the week. Monday is a public holiday in Cyprus.
There were long queues at some bank branches in the capital Nicosia as staff replenished cash machines, which have continued to operate while banks have been closed since last week.
In Moscow, Cypriot Finance Minister Michael Sarris said he was discussing possible Russian investments in the island's banks and energy resources to reduce its debt burden, as well as an extension of an existing 2.5-billion-euro Russian loan.
Russian citizens have billions of euros to lose in the island's outsized, teetering banking sector.
"The banks are the ultimate objective in any support we get, so it'll either be a direct support to the banks or the support that we get through other sectors will be channelled to the banks," Sarris told Reuters during a second day of talks with his Russian counterpart, Anton Siluanov.
He said Cyprus had no plans to borrow more money from Russia and add to its debt mountain. The Russian Finance Ministry had said on Monday that Nicosia sought an extra 5-billion-euro loan.
The chairman of euro zone finance ministers, Dutchman Jeroen Dijsselbloem, told the European Parliament in Brussels that Moscow had informed the EU it had no intention of ploughing more money into Cyprus beyond the existing loan.
"Any other options, to go further, another loan or an investment in the banks, the Russians let us know that they are not willing to do that," he said. "Of course, the Cypriot government is now talking to the Russian government on whether more can be done; I don't know the outcome of that yet."
Dijsselbloem said new loans from Russia would in any case not solve the country's debt problem, and that a revised levy on larger bank deposits was still a possibility.
"I'm not sure that this package is completely gone and failed, because I don't see many alternatives," he said.
Senior euro zone officials acknowledged in a confidential conference call on Wednesday that they were "in a mess" and discussed imposing capital controls to insulate the currency area from a possible collapse of the small Cypriot economy.
Cyprus itself refused to take part in the call, minutes of which were seen by Reuters. Several participants described its absence as troubling and reflecting the wider confusion surrounding the island's predicament.
EU officials believe at least some of the 5.8 billion they are demanding should come from the 68 billion euros in Cypriot banks, 38 billion of which are in large deposits of more than 100,000 euros, mainly from Russians and other foreigners. State guarantees would normally apply to deposits below 100,000 euros.
Hitting small savers caused visceral outrage, and the Cypriot government fears that foisting too big a burden on large depositors would wreck the offshore financial industry that forms much of the country's economy.
Among the other options, nationalising pension funds of semi-public companies could yield between 2 billion and 3 billion euros. Issuing bonds linked to future natural gas revenue is problematic because pumping any gas is years away.
"BULL IN A CHINA SHOP"
Doubts about the fate of the small nation of just 1.1 million people has shaken confidence in the single-currency euro zone and raised geopolitical tension between the EU and Russia.
Russian Prime Minister Dmitry Medvedev, who meets a European Commission delegation in Moscow on Thursday, said the bloc had behaved "like a bull in a china shop". He likened EU proposals, which would force Russian customers to contribute to the rescue of Cypriot banks, to Soviet-era expropriations.
Tuesday's parliamentary vote marked a stunning rejection of the kind of strict austerity accepted over the past three years by crisis-hit Greece, Portugal, Ireland, Spain and Italy.
European officials maintained the pressure on Nicosia.
"I cannot rule out a Cyprus insolvency," Austrian Finance Minister Maria Fekter said in an interview with the newspaper Oesterreich. "A euro exit would not achieve anything. Cyprus must act now."
With Cypriot Energy Minister George Lakkotrypis also in Moscow, officially for a tourism exhibition, speculation was rife that access to untapped offshore gas reserves could be on the table as part of a deal for Russian aid.
Cyprus is a haven for billions of euros squirreled abroad by Russian businesses and individuals - one of the reasons why Germany and other northern euro zone states are reluctant to bail it out without a contribution from bank depositors.
The proposed levy on deposits would have taken nearly 10 percent from accounts over 100,000 euros. Smaller accounts would also have been hit, although the government proposed softening the blow to spare savers with less than 20,000 euros.
Cypriots were enraged at the proposal to tax accounts with less than 100,000 euros, which are meant to be protected by state guarantees across the European Union.
Marinos Panaretou, a 36-year-old retail manager, said he had been withdrawing the maximum 500 euros every day since Saturday, when news broke of the proposed levy.
"People feel safer if we have cash on us because you don't know what you're going to wake up to," he said. "Quite simply, you don't know what's going to happen tomorrow."
European officials say the Cypriot government could have protected small savers if it imposed a higher tax on big deposits, but it refused to do so to protect the rich foreign clients of its offshore banking business.
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