By Yiannis Papadoyiannis

Cyprus authorities are seeking to isolate the Greek risk from their credit system as they are examining the possibility of separating the activity of Cypriot lenders in Greece through transforming the branches into subsidiaries.

Central Bank of Cyprus Governor Panikos Demetriades told Cypriot website Stockwatch this week that the central bank, in order to handle the risk created by the major exposure of Cypriot lenders in Greece, is considering «to turn the annexes of Cypriot banks in Greece to subsidiaries."

"We intend to have as soon as possible such structures in the system that would not allow rating agencies to downgrade us due to the exposure of Cypriot banks to Greece anymore,» said Demetriades.

Fitch this week downgraded the credit rating of Cypriot lenders owing to the Greek exposure, bringing the ratings of Bank of Cyprus and Cyprus Popular Bank from BB+ down to BB-.

Today both major Cypriot lenders operate in Greece with a network of branches. Were they to operate as local subsidiaries, the responsibility of their monitoring would fall on the Bank of Greece (BoG) and Greek authorities. For that to happen, the lenders would need to have a request accepted by the BoG, which is not at all certain.

After all, Demetriades noted that before any such request is submitted, a full inspection will need to occur, similar to that conducted by BlackRock Solutions across the Greek credit system, so as to establish the state of portfolios and of capital requirements.

Cypriot authorities will then have to proceed to the recapitalization of banks to render them sustainable and able to submit the request to Greek authorities. The final word rests with the BoG that will accept or reject the request, after taking into consideration the general state of the Greek banking system.

On Wednesday Bank of Cyprus filed a request to Cypriot authorities to receive temporary state support of 500 million euros in order to be able to meet its new capital requirements. It followed an application to the Central Bank of Cyprus for a time extension so as to continue its efforts to find the funds it requires in the market. The application was rejected.

Cyprus Popular Bank has also resorted to state support having asked for almost 2 billion euros in order to restore its capital base. The final amount for the recapitalization will be determined by the monitoring that an independent firm will conduct along the lines of BlackRock's inspection.