LIMASSOL, Cyprus (Reuters) - Cypriot banks, whose heavy Greek losses forced the island to seek an international bailout this week, should ringfence their operations in Greece by the end of 2012 to cap further risks to the economy, Cyprus’s central bank chief said on Thursday.
The euro zone minnow became the fifth casualty this week of the debt crisis that began in Greece and has spread across the euro zone, applying for emergency funds to help support local banks crippled by their losses on Greek bonds.
In his first public comments since Cyprus applied for a bailout on June 25, Panicos Demetriades also said the large size of the banking sector proportionate to the island’s economy should be addressed.
“Action should be taken to limit possible future risk drawn from the presence of Cypriot banks in other countries,” said Demetriades, who is also a member of the ECB Governing Council.
The Cypriot banking sector should disengage from the Greek economy, by turning businesses there into subsidiaries, Demetriades told a university audience in the city of Limassol.
“Our aim is to have this process concluded by the end of 2012,” Demetriades said in a prepared text.
Officials from the European Central Bank, the European Commission and the International Monetary Fund are due to start assessing Cyprus’s potential funding needs from Monday.
It already has a virtually guaranteed bill of 2.3 billion euros to recapitalize its two largest banks, with the bailout possibly going deeper into broader fiscal requirements.
Cypriot authorities say no bailout figures have been discussed, but two euro zone officials have put the total cost at up to 10 billion euros - more than half its total output.
Demetriades said that insofar as the banks were concerned, the bailout would be an opportunity to assess and pinpoint weaknesses in bank portfolios.
“I will indicatively mention - without necessarily endorsing this, since our own review is pending - the assessment by Fitch that the banks require an amount which corresponds to 33 percent of the country’s GDP,” Demetriades said.
Credit rating agency Fitch downgraded Cyprus to “junk” grade on Monday. It said recapitalizing Cypriot banks could cost up to 6 billion euros, taking into account the existing known needs of one large lender, Greek exposures and an anticipated increase in non-performing loans.
The domestic banking sector is disproportionately large, worth about 5.5 times Cyprus’s gross domestic product, or 8 times GDP when foreign banks were included, De metriades said.
Cyprus’s two main banks, Bank of Cyprus and Cyprus Popular suffered heavy losses from a bond writedown agreed by euro zone leaders to ease Greece’s debt burden.
Both require recapitalization to meet European Banking Authority regulatory requirements.
Popular Bank, the most heavily exposed to Greece, needs 1.8 billion euros which the state says it will underwrite, while Bank of Cyprus unexpectedly announced on Wednesday that it would require capital support of 500 million euros. (Reporting by Michele Kambas; Editing by Catherine Evans)