German policymakers have outlawed use of the European Stability Mechanism in rescuing Cyprus, fearing the country will remain unable to repay debts.
Officials in Brussels have wrangled over a rescue plan for Cyprus since it became obvious the island government had few resources of its own to meet debt repayments.
With debts almost equal to its annual national income of €17bn and few taxpayers to tap for funds after years as a tax haven, a plan was hatched to tax bank deposits to generate some €5bn alongside €10bn in loans on offer from the troika and a possible €2bn loan from Russia.
Inside the eurozone, Cyprus has become one of the most leveraged countries in the world. Its banking system has assets equivalent to eight times the country's gross domestic product (GDP), much of it in the form of loans linked to Russian oligarchs.
Some policymakers wanted to involve the European Stability Mechanism, which has provided loans to Ireland, Portugal and Greece. But the German outlawed this route, arguing that it would repeat the same mistake made during the rescue of Greece, which involved throwing money at a situation with little hope of ever being repaid.
Ireland forced second ranking bank bondholders to take some of the hit following its rescue by Brussels. Spain and the Netherlands have also punished bondholders rather than spend only taxpayer money rescuing their banks. However, Cyprus banks issued only small amounts of subordinated debts, leaving depositors to take the strain.
Berlin, which is still pressing for a banking union to support future bailouts, wanted Cypriots to make a cash contribution rather than place all the emphasis on loans to be paid back years later.
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