Depositors at Cypriot banks have been ordered to contribute to a financial bailout after the lenders, like Iceland’s, grew so large that they threatened to sink the nation’s economy.

Cyprus’s bank assets swelled to 126.4 billion euros ($164 billion) at the end of January, seven times the size of the 18 billion-euro economy, from 78 billion euros in 2007, data from the European Central Bank and the EU’s statistics office show.

The Cypriot government announced an unprecedented tax on deposits two days ago, seeking European Union aid after its banks lost 4.5 billion euros on Greek sovereign debt and failed to meet European capital requirements. Troubles on the Mediterranean island have resembled those of Iceland, which seized control of its banks in 2008 when they were unable to finance debt 12 times the size of the economy.

“The banks grew as they amassed funds from wealthy foreigners and now that size is too much for the country to handle on its own,” Philipp Haessler, a European banks analyst at Equinet AG in Frankfurt, said by telephone. “Cyprus is being made an example of.”

European finance ministers on March 16 ordered Cyprus to impose a levy of 6.75 percent on deposits of less than 100,000 euros — the ceiling for European Union account insurance — and 9.9 percent on funds above that.

The Parliament in Nicosia is due to vote on the measure Tuesday, which will raise 5.8 billion euros. Cyprus, which has delayed the vote twice, may ease the costs to smaller savers while still meeting the targeted amount, finance officials said. Banks will remain shut through March 20 after a holiday Monday, a government official said.

Interest-Hungry

Like Iceland, investors in Cypriot banks were chasing interest on deposits that looked increasingly attractive as the returns available in other parts of the euro area declined. In January, Finance Minister Wolfgang Schaeuble demanded an investigation into whether Russia is using the island as a destination for money laundering. Cypriot officials deny the country is a haven for illegal money.

Cypriot banks paid an average 4.45 percent on deposits of less than two years in January compared with 4.25 percent in 2008, according to data from the Central Bank of Cyprus. The European Central Bank slashed rates to 0.75 percent from 4 percent in the period and German banks lowered theirs to 1.5 percent from 4.01 percent.

Of the 68.4 billion euros in deposits held by non-bank clients at Cypriot lenders at the end of January, 21 billion euros, or 31 percent, was from clients outside the euro area and 7 percent from other nations inside the currency bloc, according to the Cypriot central bank.

Russian Clients

The country’s three biggest listed lenders — Bank of Cyprus Plc, Cyprus Popular Bank Pcl and Hellenic Bank Pcl — had a total of 6.5 billion euros of losses in 2011 after writing down the value of their Greek bond holdings.

Russian companies and individuals have $31 billion of deposits in Cyprus, according to Moody’s Investors Services.

More than a third of the branches of the Bank of Cyprus, which held 27 percent of the country’s deposits at the end of September, are located in Russia.

Russian businessman Dmitry Rybolovlev is the largest shareholder in the Bank of Cyprus with a 9.7 percent stake held via British Virgin Islands-based trust Odella Resources, according to data compiled by Bloomberg. Rybolovlev, worth $9.4 billion, bought an apartment at 15 Central Park West, New York, for $88 million last year.

Sunday, President Vladimir Putin called the tax “unfair, unprofessional and dangerous” in a statement posted on the Kremlin website. A spokesman for Putin wasn’t immediately available to comment on how much Russian money is held in Cypriot banks.

‘Bank Runs’

European leaders are pushing the government to tap banks’ deposits because their corporate bonds are limited in size, reducing the effect of any Greece-style haircut. The country’s small tax base also hampers its ability to raise funds.

“There was no other way as there was no debt outstanding at Cyprus’s banks that they could impair,” Christine Schmid, a Zurich-based analyst at Credit Suisse Group AG, said by phone. “There was no option. So they went after the deposits.”

The Cypriot charge on deposits is raising concern that other European states such as Spain or Italy might levy similar one-off taxes to help rescue their troubled lenders, said Alexander Friedman, global chief investment officer at UBS AG.

“The depositor bail-in sets a dangerous precedent, rendering deposit insurance partially worthless,” Friedman, who is based in New York, said in an e-mailed report. “While being flagged as an exceptional situation, this may accelerate problems of other weaker banks in the European periphery by increasing the risk of bank runs.”

Losing Faith

Italian and Spanish banks are smaller than their Cypriot peers relative to the size of their respective economies. Spanish banking assets total more than three times the size of the economy while Italy’s banks have assets equal to more than 2 1/2 times gross domestic product.

“Cypriot banks aren’t normal but European policy makers should have seen it coming,” Klaus Fleischer, a professor of banking and finance at the University of Applied Sciences in Munich, said by phone. “Deposits are deposits regardless of where they are in Europe and with people watching this in other countries, there’s a risk they lose faith in the system.”