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Cyprus Aid May Stress Bank Funding Elsewhere in Europe, IIF Says

March 27 (Bloomberg) -- Banks in Portugal, Spain and Italy may come under funding pressure after a deal earlier this week in Cyprus rescued the island’s financial system at the expense of bank creditors, the Institute of International Finance said.

European governments and the International Monetary Fund agreed two days ago to loan Cyprus 10 billion euros ($12.8 billion) as long as the country liquidated its second-largest bank and forced losses on bank bondholders and deposits of more than 100,000 euros.

“This new approach is apt to put funding stresses on banks in weaker economies -- especially Portugal, Spain and Italy,” the Washington-based association of the biggest commercial and investment banks said today in a report. “Instead of severing the link between bank and sovereign balance sheets, the Cyprus deal will have deepened these links: Banks exposed to weak sovereigns will have their depositors and creditors haircut, pulling down the economy and public finances.”

Cyprus may impose controls on money transfers before its banks are scheduled to reopen tomorrow. The country’s leaders are seeking to prevent the flight of money from the island’s lenders, which have been closed for almost two weeks.

European Central Bank President Mario Draghi pledged in July to do “whatever it takes” to protect the euro.

“It is plausible that markets have too much confidence in ECB support and now, once again, underpricing some form of break-up risk,” IIF said in its report.

To contact the reporter on this story: Kasia Klimasinska in Washington at kklimasinska@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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