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Cyprus: Question Is How Small Will Banks Go?

Cypriots line up at a Laiki Bank ATM to withdraw their money.
Katie Slaman | CNBC
Cypriots line up at a Laiki Bank ATM to withdraw their money.

Update: The President of Cyprus Nicos Anastasiades, and the delegation accompanying him arrived in Brussels Sunday afternoon, where effort will begin at the Eurogroup about the loan agreement between Cyprus and the Troika.

In the meantime, in Nicosia, following instructions by Anastasiades, the political party leaders have been advised to be present at the Presidential Palace at 5 p.m., Cyprus time.

The party leaders, headed by the Acting President of the Republic and President of the House of Representatives, Yiannakis Omirou,will be briefed by President Anastasiades about his contacts until that time,in view of the Eurogroup meeting.

It appears the fight is no longer about whether both of Cyprus large banks will get smaller — they will. The only question is how.

Bankers, politicians, and bureaucrats are throwing around all kinds of bank restructuring phrases, such as "bail-ins" and "resolving"and "haircuts."

But suffice it to say two banks — Laiki and Bank of Cyprus — will be shells of what they once were, if they even continue to exist at all.

Cyprus' overgrown banking sector has been crippled by exposure to crisis-hit Greece, and the EU says the east Mediterranean island must raise 5.8 billion euros on its own before it can receive a 10 billion euro bailout.

Cypriot President Nicos Anastasiades, seeking a last-minute reprieve from financial meltdown at talks in Brussels on Sunday, has a "very difficult task" ahead of him if he is to save the island's economy, a government spokesman said.

With Cyprus facing a Monday deadline to avert a collapse of its banking system and potential exit from the euro, late night talks Saturday in Nicosia to seal a bailout from the EU and International Monetary Fund broke up without result.

A possible run by depositors on Cypriot banks has kept the banks closed for a week but they are scheduled to reopen Tuesday. The only money available has been what depositors can take from automatic teller machines before reaching their daily account limits.

However, we can report two things with near certainty:

1. In the two sick banks, accounts with less than €100,000 will be fully protected.

2. Anything above €100,000 will not. What happens to those larger accounts depends on the outcome of today's negotiations and what financial engineering is chosen.

There are the possibilities, depositors in could see between 30 percent and 50 percent of their accounts above €100,000 converted to stock in the new, presumably stronger and better capitalized bank.

Or, if they choose to use the goodbank\badbank method, then those with larger accounts will have to wait for the proceeds of the sale of assets from the "bad bank."

They could receive back anywhere from 50-70 percent of their money according to those familiar with the numbers and the quality of the assets.

At different times in the negotiations, both of the above options have been on the table for both banks.

The government of Cyprus has argued for the first method to be used for both banks, that way they could both be left standing. But its the costlier option, as they would both require more capital.

Their European lenders partners have pushed for the second option to be used on both, because it would require the least amount of bailout money. But that means both those banks wouldn't be left standing, at least not as they are known now.

Its possible they use one method for one bank, and one method for another bank.

With additional reporting from CNBC's Patrick Allen from Reuters wire service.