UPDATE 2-S&P says Cypriot deposit grab may set euro zone precedent

By Marc Jones

LONDON May 15 The grab on bank deposits that accompanied Cyprus's bailout could be repeated elsewhere in the euro zone, and the bloc's banking union may not be strong enough when it is introduced, Standard & Poor's said on Wednesday.

"We believe that the events in Cyprus highlight the increased reluctance of financially stronger euro zone countries to make their taxpayers' funds available to recapitalise banks outside their home jurisdictions," the credit ratings agency said in a report.

"For this reason, although the key features of the Cypriot banking system are not shared by other euro zone countries, we consider that the bail-in may indeed create a precedent."

Speaking at the London School of Economics, Athanasios Orphanides, who headed Cyprus's central bank during much of the run up to the crisis, slammed the handling of the situation by both the island's government and euro zone leaders.

"I read this (deposit grab) as another Deauville," Orphanides said, referring to the groundbreaking agreement between German Chancellor Angela Merkel and then French President Nicolas Sarkozy to impose losses on Greek bondholders.

"It is not yet clear what has been done to the banking sector in the periphery... The issue is how this may play out going forward."

S&P's report also raised concerns that the euro zone's plans for a banking union - designed to break the link between costly bank bailouts and unmanageable sovereign debt levels - may fall short of requirements.

The union is due to come into force by mid-2014 but there has been substantial backsliding on the original blueprint, with Germany in particular resistant to committing taxpayers' money to supporting banks outside its borders.

S&P credit analyst Richard Barnes said the increasingly "minimalist"-looking plans would "do little to make the euro zone a more cohesive monetary union or address banks' direct and indirect dependence on the creditworthiness of their national governments."

"Unless the banking union delivers greater integration than currently appears achievable, the creditworthiness of banks will likely remain dependent on their home sovereigns' creditworthiness. Therefore, they would remain vulnerable to any further deterioration in the operating environment," he added.