Ratings agency Standard & Poor's cut Cyprus' government debt grade by one notch on Wednesday and warned it could issue the euro country another downgrade because of the financial system's exposure to debt-saddled Greece.
The agency the Cypriot financial system's "significant" exposure to Greece represented a "ratings weakness."
S&P credit analyst Benjamin Young said "the increasing likelihood that the Greek government will restructure its debt" heightened the risk that Cyprus would be impacted negatively.
Greece was saved from bankruptcy last May by a 110 billion euro ($155 billion) package of bailout loans from an EU-led international bailout.
S&P said Cyprus' rating, which was cut to A-minus from A, could be lowered further if the country's financial system's credit risks spike due to a deterioration in the Greek market situation or the island's own funding conditions.
It added that the rating could also come under pressure if financial market turmoil hurts the country's public finances.
But S&P said the island's rating could stabilize at current levels if the banking sector shows "strong resilience" and independently bolsters its capital levels to offset its exposure to Greece.
S&P had already cut Cyprus' grade by a notch last November over the island's Greek exposure. Last month, Moody's cut its rating on Cypriot government bonds by two notches amid concerns over the state of the public accounts and banks' exposure Greece. The Fitch ratings agency put Cyprus on notice in January for a possible downgrade, but noted it did not expect the AA minus rating to be lowered by more than one notch.
Cyprus' Finance Ministry said that the island's financial sector remains robust.
"The increased flow of foreign deposits in Cyprus over the last 12 months is a vote of confidence by the market in the Cypriot financial system," the ministry said in a statement on Wednesday.
On Monday, Cyprus' Central Bank Governor Athanasios Orphanides said that a proposed bank stability fund needs at least 500 million euros ($700 million), or 3 percent of the island's national income, to sufficiently backstop the financial sector in case it runs into trouble.
Orphanides called the 500 million euros "an initial target," adding that the independent fund — which is due to be set up within the next six months — is essential to ensuring the financial sector's credibility regardless of how the island's public finances are faring.
Moody's said last week that the Cypriot banking system's total assets were about 110 billion euros — or 6.5 times the islands' gross domestic product and that about 2.7 billion euros would be needed to restore its core Tier 1 capital to current levels if its stress test assumptions materialize.
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