A weekend agreement between Cyprus and its European partners called for the government to raid bank accounts as part of a €15.8 billion ($20.4 billion) financial bailout, the first time in the eurozone's crisis that the prospect of seizing individuals' savings has been raised.
Facing outrage, Cypriot authorities delayed a parliamentary vote on the seizure and ordered banks to remain shut until Thursday while it tries to modify the deal to reduce the hit on people with small deposits.
Several hundred protesters gathered outside the parliament building, with some chanting "thieves, thieves" and "people wake up, they're drinking your blood." One demonstrator dumped sheep wool and animal feces in front of a line of police officers guarding the entrance. Protesters later marched onto the presidential palace.
"It's a precedent for all European countries. Their money in every bank is not safe," said lawyer Simos Angelides.
In order to get €10 billion ($13 billion) in bailout loans from international creditors, Cyprus agreed to take a percentage of all deposits — including ordinary citizens' savings. The surprise deal stoked fears that deposits in other countries could be targeted.
Financial stocks fell sharply across euro, as did the euro, even though the Cypriot economy accounts for only 0.2 per cent of the combined output of the 17 European Union countries that use the currency.
"The damage is done," said Louise Cooper, who heads financial research firm CooperCity. "Europeans now know that their savings could be used to bail out banks."
The Cypriot government is now trying to modify the terms of the original plan and in particular to get a better deal for small savers with less than €100,000. The weekend deal foresaw a one-off charge of 6.75 per cent on those savings, rising to 9.9 per cent for those above the €100,000 mark.
While trying to make the package more appetizing for those with low savings, the government has to make sure that the total raised remains the same at €5.8 billion.
One solution doing the rounds is to make the tax more graduated: placing a one-time 3 per cent levy on deposits below €100,000, rising to 15 per cent for those above €500,000.
Another alternative pitched by European Parliament President Martin Schulz is exempting savings up to €25,000 from the tax. Schulz is also a member of Germany's opposition Social Democrats.
Still, the government has a battle to get a majority in the 56-member Parliament after some 25 lawmakers from communist AKEL, socialist EDEK and the Green party said they would vote down the levy that they have criticized as disastrous. Even centre right party DIKO, a government ally which holds eight seats, is wavering over its support.
Any modification to the deposit seizure must be approved by the other finance ministers in the eurozone — who will hold a phone conference later Monday — before the Cypriot parliament can vote on it.
The stakes are high for the country of a million people, because a rejection of the package could see the country go bankrupt and possibly out of the common euro currency. Officials also fear a run on Cypriot banks no matter which way the voting goes, though immediate consequences for other eurozone countries are limited.
The decision by Cyprus' 16 partners in the eurozone and the International Monetary Fund marks a significant shift in the way the debt crisis is being addressed. It is the first time that savings have been touched in a financial bailout. While it is not expected to cause a run on banks in Italy or Spain, it may make savers more likely to withdraw their funds.
"This sets a worrying precedent for Spain and Italy, but doesn't make widespread bank runs imminent," said Dario Perkins, an analyst at Lombard Street Research.
Cypriot authorities said they had no choice in the matter.
"I believe (the levy) was a bad idea but they imposed it on us," Cypriot Finance Minister Michalis Sarris said Monday.
Cyprus' government spokesman, Christos Stylianides, accused eurozone countries of using "blackmail tactics" by insisting that if Cyprus did not raid savings accounts, it would have to immediately shut down the country's top two lenders.
White House press secretary Jay Carney declined to comment on Cyprus' savings grab. "We're obviously monitoring the situation right now," Carney said.
One of the main reasons given for the raid on deposits is that Cyprus' banks, which are in deep trouble after taking huge losses on bad Greek debt, are eight times the size of the economy. The Cypriot government would be unable to pay back the amount of loans it would need to rescue the banks.
Another reason for the raid is that Russian money accounts for a large part of the banks' deposits. An estimated €20 billion ($26.17 billion) of Russian money sits in Cypriot banks, part of it thought to be linked to money-laundering. European officials were loathe to give Cyprus bailout loans to protect those Russians' savings.
German Chancellor Angela Merkel needs to win support for a Cypriot bailout in Parliament amid widespread skepticism in the country over whether Cypriot authorities have done enough to combat money laundering.
"It is good that the Cypriot government, the Cypriot parliament, are now taking more time to reach a better solution," Germany's Vice Chancellor Philipp Roesler told reporters in Berlin. "But it is important to us that the overall volume is achieved all the same.