Ben Aris in Moscow -

The decision by the Cypriot government to grab up to 9.9% of deposits in its banking system is the financial equivalent of the Magnitsky bill as far as the Kremlin is concerned.

"The decision is unfair, unprofessional and dangerous," Russian President Vladimir Putin said of the deal struck between the German-dominated EU finance ministers meeting and Cyprus over the weekend in Berlin.

Cyprus is the favourite offshore financial haven for Russian business. As of January, €43bn of the €68bn deposited in Cypriot banks was held by domestic residents, according to the central bank. Thus more than €20bn came from the rest of the world, with the bulk of that believed to be from Russia. However, many Russian companies are domiciled in Cyprus and so technically count as domestic, meaning the volume of Russian cash in the banks could well be more than that €20bn.

Under the terms of the "bail-in" rescue package, the government will raise a one-time levy of 9.9% on depositors with more than €100,000 in their accounts and 6.75% on the small depositors. The government will then use the approximately $5.8bn raised to bail out the banking system, which would otherwise collapse without help.

The EU has agreed to come up with another €10bn, down from the original €17bn that Cyprus said it needed at the start of the talks. The percentages may change in the next 24 hours, as the Cypriot parliament needs to approve the plan and there is inevitably huge opposition to it. Therefore, the amount small depositors in particular will have to pay could well be reduced.

The deal has been widely condemned by commentators, as it undermines the very foundations of the European banking system. All European deposits are supposed to be protected by a deposit insurance scheme that guarantees the safety of deposits irrespective of what happens to the bank holding it.

The reason why Europe has contemplated such an unorthodox solution is the political problems that Germany has with using its taxpayer money - as the bulk of the EU money will come from Germany - to bail out Russian oligarchs and gangsters hiding money abroad.

"The driver for the latest attempt to bail-in depositors appears to be German politics, and concern therein that German tax-payers' money was likely being used to bail-out the weight of Russian deposits in the Cypriot banking system," Timothy Ash, a strategist at Standard Bank, wrote in an emailed note. "German politicians seem to have adopted a very moralistic approach to the Cypriot bail-out, which may well now reflect 'bail-out' fatigue more than anything, plus the close proximity now of Bundestag elections [due in September].

The Cypriot authorities have vigorously denied the allegations and highlighted recent multilateral reviews have given the country a clean bill of heath in this respect. However, with the banking sector several times larger than the size of the economy, clearly Cyprus is keen to hang onto to its financial sector as a major source of income.

Lack of trust

Much has been made in the press of €25bn, almost one-third of Cyprus' deposit base, being comprised of Russian money. But if the bail-in haircut does go through, it will do little damage to Russia in the short term. Ivan Tchakarov, chief Russia and CIS economist with Renaissance Capital, estimates that Russian companies will lose a total of $1.9bn assuming total deposits of about $19bn, or a mere 0.15% of Russian GDP.

However, if Cyprus follows up with capital controls on the movement of foreign money in and out of the country, the debacle could cause losses of as much as 2% of Russian GDP, which would really hurt, argues Tchakarov. Russian banks have extended a total of $40bn of loans to Cypriot companies (most of which are actually shell entities for Russian businesses) that could get caught in the web.

Undermining the deposit insurance system is extremely dangerous and the reason why the Kremlin is so livid. The entire banking business is based on trust: banks take in deposits and on-lend them to borrowers, but this system only works if depositors don't all demand their money back in cash at once. The deposit insurance system was established to provide extra reassurance to depositors, so to undermine it threatens the very foundation of the entire European banking sector.

The EU officials made it clear that this was a "one-off" solution and would not be repeated in other countries, leaving the Kremlin with the impression that the bail-in deal is another example of selective legislation specifically designed to punish Russia.

Indeed, the legality of the deposit grab is already being questioned. "I would be surprised if some Cypriots do not try and test this all in the European courts - assuming that the Cypriot parliament does not throw this out this week, which seems quite a high probability in my mind," says Ash. "It seems bizarre that different conditions are being imposed on Cyprus to other bail-outs recently rolled out across the Eurozone... And incredible by such a move that the Troika [European Commission, International Monetary Fund and European Central Bank] seems willing to jeopardise the sanctity and standing of EU deposit insurance schemes, and at a huge potential risk of a broader loss of confidence in banking systems, and indeed the European crisis resolution system [for only around €7bn saving in bail out costs]."

Last year the US Congress passed the so-called "Magnitsky Act", which imposes travel restrictions and freezes US assets of any Russian officials implicated in the death of campaigning lawyer Sergei Magnitsky while in pre-trial detention in 2009 and involved in any other human rights violations and corruption.

The bill is supposed to give the US government putative powers against human rights abusers, however it has only been applied to Russian officials. Especially galling for the Kremlin, newly appointed Secretary of State John Kerry was in Uzbekistan last week to renew the US' friendship with the Central Asian dictatorship, despite that country's far worse record on human rights.

Financial markets were in uproar on Monday, March 18 as investors fled to safety. All eyes are now on Cyprus' parliamentary vote, where the government probably has enough votes to see the bail-in through, according reports.

Investors' fear about contagion is back with a vengeance, with financials leading the biggest declines as risk appetite for these stocks has been dented massively.

If the Cypriot levy comes into effect, then there would be a big disincentive for depositors in any of the troubled countries on the periphery of Europe to keep their money in local banks, as it's clear the EU now has the power to grab savings to rescue struggling banks while leaving senior bank bondholders untouched. Undermining the trust in the already wobbly banking sector, especially if motivated by short-term political goals, is profoundly irresponsible.

The question everyone in Europe is now asking: who will be next?