Would a bailout for Cyprus mean underwriting dirty money?

When compared to the hundreds of billions of euros used to prevent Greece from collapsing, the €11 billion needed to recapitalize the banks of Cyprus is a relatively small sum. But Cyprus, the fourth eurozone country applying for financial aid in order to prevent a state bankruptcy, has potential creditors pausing just the same.

Their reason: concerns that Cypriot banks are a haven for money laundering.

Discussions about a bailout package for Cyprus – which the Eurogroup finance ministers announced earlier this week would be put off until March – have been overshadowed in the past few months by allegations that the country’s unusually large banking sector was used by Russian oligarchs to park and launder dirty money.

“We have serious doubts in the Cypriot business model,” says Carsten Schneider, financial spokesman for Germany’s Social Democrats, the main opposition party.

The Republic of Cyprus, an island in the eastern Mediterranean, has been a member of the European Union since 2004 and adopted the euro as its currency in 2008. Banking, tourism, and shipping are the biggest industries. Last year, the left-wing government in Nicosia announced it would need international help to keep the country afloat, after rating agency Fitch downgraded Cyprus’s credit rating to junk status. Fitch justified its decision with the heavy exposure of Cypriot banks to bad Greek debt.

And herein lies the problem. Large parts of the bailout that Cyprus is asking from the EU and the International Monetary Fund (IMF) would be used to recapitalize Cypriot banks, almost €11 billion ($14.7 billion) of the €17 billion ($22.7 billion) aid package the country needs. Potential creditors in northern Europe, namely Germany, are balking at the idea.

“How am I supposed to explain to my voters that their taxes are used to bail out Russian billionaires?” asks Mr. Schneider, who is also one of the opposition MPs whose vote Chancellor Angela Merkel would need were she to put a bailout for Cyprus to the German parliament.

His suspicions are based on a confidential report compiled by Germany’s external secret service, the Bundesnachrichtendienst (BND). Last November, German media quoted the BND as saying that Russian citizens had deposits of €26 billion ($34.7 billion) in Cypriot banks, more than the country’s GDP. According to the report, Cyprus facilitates money laundering by generously granting citizenship to wealthy foreigners. Up to 80 Russian oligarchs gained access to the common European market this way, the BND says.

Cyprus denies

Cyprus vehemently rejects these accusations, pointing out that all European legislation on banking and business regulations have been enshrined in Cypriot law, too. On Tuesday, Panicos Demetriades, governor of the Central Bank of Cyprus, insisted in an op-ed in the Financial Times that his country has more measures against money laundering in place than other eurozone nations.

“This is undoubtedly true,” says Hubert Faustmann, a German teaching history and international relations at Intercollege in Nicosia. “What is less certain is that these rules are actually enforced.”

It is a doubt shared by European leaders. A meeting of eurozone finance ministers earlier this week postponed any decisions about a Cypriot bailout until March.

In the meantime, general elections in Cyprus on Feb. 17th could bring a change of government, with polls suggesting that the Communist AKEL party might have to hand over the presidency to the center-right Democratic Rally party. Its leader, Nicos Anastasiades, would then have to negotiate the bailout conditions.

That's if there is a bailout. Rescue rules require there to be “a danger for the stability of the eurozone as a whole,” German Finance Minister Wolfgang Schaeuble told reporters earlier this week in Brussels before meeting his colleagues. “This has to be met. We will see.”