To help pay for the $13 billion European bailout, the government plans to take up to 10 percent from all savings accounts, angering those who say they aren't responsible for the economic crisis. CNBC's Sue Herera reports.
Cyprus's parliament overwhelmingly rejected a proposed levy on bank deposits as a condition for a European bailout on Tuesday, plunging one of the smallest European states closer to financial oblivion.
The rejection, with 36 votes against, 19 abstentions and one absence, brought Cyprus to the brink of financial meltdown.
But jubilant crowds outside parliament broke into applause, chanting: "Cyprus belongs to its people."
"The voice of the people was heard," said Andreas Miltiadou, a 65-year-old pensioner among the demonstrators.
The European Central Bank said it was in contact with its IMF and EU partners and remained committed to providing liquidity within certain limits.
"The ECB takes note of the decision of the Cypriot parliament and is in contact with its troika partners," the bank said in a statement, according to Reuters. "The ECB reaffirms its commitment to provide liquidity as needed within the existing rules."
The widely criticized bailout deal looked set to collapse despite a last-minute compromise attempt Tuesday.
The European deal could also be scuppered by a furious Russia, which is one of the biggest foreign investors in Cyprus and which stands to be among the biggest losers.
Reuters said the situation had “potentially severe consequences for the rest of the troubled euro zone.”
One analyst told CNBC Russia might even seek revenge by disrupting energy supplies to Europe. Russian President Vladimir Putin on Monday criticized the bailout as "unfair, unprofessional and dangerous."
There were media reports that Cypriot Finance Minister Michael Sarris, who was in Moscow Tuesday, had resigned, but he told Reuters by text message that there was "no truth" to the claim, which had further rattled nerves over the crisis.
Cypriots awoke Saturday to the surprise announcement that up to 10 per cent of their bank account deposits might be seized as part of a $13 billion rescue package agreed by the European Union countries and the International Monetary Fund (IMF).
Banks on the Mediterranean island have been ordered to remain closed until Thursday amid fears of a massive rush to withdraw deposits in advance of the deal, further precipitating a financial collapse that could cause an economic ripple effect throughout the region and beyond.
Thousands withdrew savings over the weekend, emptying ATMs and sending global money markets into a steep dive.
Panicos Demetriades, chief of the country's central bank, told the Cypriot parliament's finance committee Tuesday that banks stand to lose more than 10 percent of their deposit base within a matter of days if a levy on bank deposits is imposed.
The European bailout has been widely criticized by commentators. In an editorial, Bloomberg said it was the “worst” decision of the entire regional financial crisis, while the Economist panned it as "unfair, short-sighted and self-defeating."
Cypriot and euro-zone officials sought to soften the initially proposed levy of up to 9.9 percent, ensuring that deposits below the value of $25,000 were not affected, in order to ease the burden on small savers and overcome lawmaker opposition, CNBC reported.
Adding to the uncertainty, Greek media reports have suggested Russian energy giant Gazprom might offer Cyprus an alternative bailout deal.
Russian citizens account for the majority of the billions of euros held in Cypriot banks by foreign depositors, and Moscow has already given the Mediterranean country a sovereign loan to ease its financial crisis.
Steve Keen, professor of economics and finance at Australia's University of Western Sydney, told CNBC that Russia could retaliate against the perceived proxy attack on its citizens and their money.
"If you try to target the Russians, and there's President Putin acting under the image of the 'strong man' of Russia, why would he not then decide to shut down gas supplies to Germany until that was righted?" he said.
“If you're going to attack money laundering then attack it directly, don't make Cypriot peasants and small businessmen collateral in your campaign against Russian oligarchs. Declare the campaign rather than doing it under the carpet like this too," he added.
Reuters and NBC News' Ian Johnston contributed to this report.
This story was originally published on Tue Mar 19, 2013 9:01 AM EDT