Cyprus Ignored Bailout and Bank Warnings: EU's Rehn

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Cyprus was warned about its "excessive economic imbalances" and was told that financial assistance was "unavoidable" months before it requested aid, Olli Rehn, the vice president of the European Commission, told an economics committee in the European parliament on Wednesday.

Speaking at an extraordinary meeting of the European Committee on Economic and Monetary Affairs in Brussels, Rehn said Cyprus' problems had built up over "many years."

"We need to ask why Cyprus found itself in such a grave financial situation that it had to request aid," Rehn told the committee. "The Commission warned Cyprus about its accumulating problems to tackle the banking, fiscal and monetary problems in 2011."

"In November 2011, [the European Commission] said a financial assistance program would be unavoidable but even so they [Cyprus] only asked for assistance in June 2012. It is unfortunate that it took Cyprus over half a year to accept the gravity of its financial situation…and its excessive economic imbalances," Rehn said.

"By March the economic situation had deteriorated so badly that our preference for gradual economic sustenance was not possible anymore."

Cyprus was the fourth euro zone economy to request an international bailout in March but unlike other aid recipients, the country was forced to impose a levy on banking deposits over 100,000 euros. The deal was criticized as being a covert method of tackling perceived money-laundering practices by foreign depositors enjoying Cyprus' lax financial regulation and low tax rates.

(Read More: Cyprus Shuts Banks Until Tuesday, Seeks Russia Aid)

Rehn said that a "deep restructuring" of the banking sector would allow Cyprus to recover and "lead to a small but more resilient and transparent banking sector providing the framework for anti-money laundering."

The troika of lenders (the ECB, International Monetary Fund and European Commission) has been criticized for delaying financial assistance to Cyprus, though Rehn said that a tranche of aid agreed to in March would be disbursed in a "couple of days' time." "Delays are very costly to the economy, the society and financial stability, he said.

Jörg Asmussen, a member of the executive board of the European Central Bank (ECB) said that Cyprus'bailout had "presented a challenging and exceptional situation."

He told the committee that the country's large financial sector imbalances,"imprudent lending practices" and banks' exposure to funding "vulnerabilities"were all to blame for Cyprus' crash. And, he added, that the country's banking sector still presented risks.

(Read More: Europe Must Fix Banking Mess: Ex-Central Bank Chief)

"Despite the unprecedented steps taken so far, the banking sector has still not been fully stabilized,"Asmussen told the committee.

Asmussen, a German economist,defended the "bail-in" of bank depositors, saying those depositors would "not have been better off in the case of liquidation [of Cyprus' banks]." He said the case highlighted the need for a Europe-wide banking union.

(Read More: Germany Backtracks on Euro Zone Banking Union)

"The Cypriot case has been a salutary reminder of the importance of establishing a banking union as swiftly as possible. Only then will be able to break the negative interactions between sovereigns and their banking systems."