And then there were five: Cyprus seeks EU aid

NICOSIA/ATHENS (Reuters) - A fifth euro zone country turned to Brussels for emergency funding on Monday when Cyprus announced it was seeking a lifeline for its banks and its budget, hours after Spain submitted a formal request to bail out its banks.

Global share prices and the euro slid as investors bet that European leaders - due to meet this week for the 20th time since the currency zone's debt crisis hit Greece in 2010 - would fail to come up with radical measures to back up weak countries.

Germany's Chancellor Angela Merkel dashed any hope that Berlin would allow joint bonds issued by the euro zone or other measures sought by partners.

Cyprus joins Greece, Ireland, Portugal and Spain in seeking EU rescue funds, meaning more than a quarter of the 17 euro zone members are now in the bloc's emergency ward. Italy's funding costs have soared too, which means it could be next.

Spain formally submitted its request for up to 100 billion euros of funds to bail out its banks, agreed on June 9.

Tiny Cyprus has just four days to raise at least 1.8 billion euros - equivalent to about 10 percent of its domestic output - to meet a deadline set by European regulators to recapitalize Cyprus Popular Bank, its second largest lender which saw its balance sheet hurt by bad Greek debt.

Finance Minister Vassos Shiarly said the country would also seek enough money to help with its budget deficit. The full amount would be decided over the course of weeks.

"The amount will be as much as it may be needed to cover the recapitalization and fiscal requirements," he told Reuters.

With its coffers emptying rapidly and hurtling towards an immovable deadline, Cyprus suffered a further sovereign credit rating cut on Monday by Fitch, to the junk BB+ grade. It is already shut out from raising new funds on capital markets, with yields on existing bonds well into double digits.

An island with just 1 million residents, Cyprus has a disproportionately large financial sector that is heavily exposed to Greece, a neighbor more than 10 times the size with which it shares a language, culture and close political links.

It received 2.5 billion euros in a loan from Russia last year and has been scrambling for funding from Moscow or Beijing to avoid the terms Brussels imposes in return for EU bailouts.

Jean-Claude Juncker, head of the Eurogroup of euro zone leaders, said Cyprus would have to negotiate aid conditions with the EU and European Central Bank.

"This will include measures that will address the main challenges of the Cyprus economy, primarily those of the financial sector, and I expect that Cyprus will engage with strong determination in the required policy actions," he said.

Greece, which brought the euro zone back from the brink of breaking up by electing a government this month committed to implementing its 130 billion euro bailout program, was also thrown into confusion on Monday when its new finance minister, Vassilis Rapanos was forced to resign due to ill health.

Newly-elected Prime Minister Antonis Samaras, who wants to win easier terms from the EU for the bailout, will also miss the European summit because of an eye operation.

A visit by "troika" inspectors representing Greece's international creditors - the EU, European Central Bank and IMF - which was due this week has been postponed.

A German spokesman said no decisions would be taken on Greece at the two-day Brussels summit which starts on Thursday.

SUMMIT SKEPTICISM

Leaders will discuss a cross-border banking union, closer fiscal integration and a possible debt redemption fund.

But Merkel, who leads Europe's biggest economy and the main contributor to its rescue funds, said sharing debt liability within the 17-nation euro area would be "economically wrong and counterproductive".

France, Italy and Spain have pushed hard for steps towards mutualising debts and liabilities through a joint bank deposit guarantee, a common bank resolution fund and issuing common euro zone bonds. The conservative German leader adamantly rejects such ideas and is keen to squelch them before the meeting.

"When I think of the summit I feel concerned that yet again we will have too much focus on all kinds of ways of sharing debt," Merkel told a conference in Berlin.

Critics say that by refusing any such collective solutions, Berlin risks unleashing speculative attacks on Spanish and Italian bonds, hastening possible future bailout requests which the euro zone's rescue funds are too small to manage.

Spanish and Italian bond yields rose on Monday as doubts spread that the EU summit would take decisive action. Investors sought shelter in U.S. government debt.

Spanish Economy Minister Luis de Guindos asked for up to 100 billion euros ($125 billion) in a letter to Juncker, saying the final amount of assistance would be set at a later stage.

The letter formalizes Spain's request for the bailout, agreed on June 9, and confirmed its intention to sign a Memorandum of Understanding by July 9. He said the amount should cover all banks' needs, plus a buffer.

The EU's top economic official, Olli Rehn, said a deal on terms for the loan from Europe's bailout funds could be concluded within weeks and would include reforms of the financial sector.

The rescue is intended to help Spanish lenders recover from the effects of a burst real estate bubble and a recession, which have piled up bad loans and sinking property portfolios.

Prime Minister Mariano Rajoy told business leaders he would soon take new measures to revive economic growth and create jobs. He gave no details but said the government remained committed to cutting the public deficit.

Two independent audits last week put the Spanish banks' capital needs at up to 62 billion euros.

Some economists believe the rescue is merely a prelude to a full bailout for the Spanish state, which saw its borrowing costs soar to euro era record levels above 7 percent early last week, although they later eased.

A working document prepared by top EU officials calls for the gradual introduction of a banking union, starting with supervisory power for the European Central Bank and developing a deposit guarantee scheme based on pooling national systems, with a levy-funded bank resolution fund.

Berlin has so far rejected any joint deposit guarantee or resolution fund, as well as proposals that euro zone governments should assume joint liability for each other's debts.

Merkel and French President Francois Hollande, whose relationship is testy, will have one more try at narrowing their differences before the summit on Thursday and Friday.

The German leader has shown no sign of relenting in her refusal to take on new liabilities for German taxpayers until other euro zone states agree to hand more sovereignty over national budgets and economic policies to EU institutions.

(Additional reporting by Michelle Martin and Stephen Brown in Berlin, Catherine Bremer in Paris, Fiona Ortiz and Julien Toyer in Madrid, Luke Baker and Jan Strupczewski in Brussels and Karolina Tagaris in Athens; Writing by Peter Graff and Paul Taylor; editing by Philippa Fletcher)

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