The Cypriot government says the next few hours will be critical in negotiations with the "troika" of European creditors over the bailout of the Cypriot banking system.

Cyprus has to pass nine bills related to banking reform and raising funds to contribute to the bailout and send a proposal to the EU for acceptance in order to stave off a total collapse of its banking system next week.

In an email, Société Générale analyst Sebastien Galy runs through the latest developments: Germany is balking at a Cypriot plan to collateralize church assets and future natural gas revenues in order to raise funds, and a vote on the plan in parliament has been pushed back a few hours.

Galy also provides a link to ostrichpillow.com. The implications are fairly straightforward.

Here's Galy (emphasis added):

It all means we have no solution, because that solution is not deemed politically viable domestically at this point. The market knows it, but is concerned that the usual last minute European deal will lead to a brutal short squeeze of bearish positions, a fair fear.

Cyprus is increasingly portrayed as a poker player in Germany, while for some reason it is displaced from the front pages in french newspapers, suggesting politically support in Europe seems weak, outside the self inflicted wound on the below 100K tax on deposit proposal.

Fellow SocGen strategist Vincent Chaigneau outlined in a separate note how that might happen:

Cyprus deal still achievable... Arguably, we could well have a positive surprise on Cyprus over the coming days. The amounts at stake (a €17bn rescue) are big relative to Cyprus’ GDP, but small at the EU level. The ESM could easily fund the €17bn bailout, but the EU believes this would over-burden Cyprus’s government debt. Hence, the requirement that some losses are recognised, so that other parties contribute to the funding. Hence, the idea of imposing a levy on deposits (effectively a haircut), for €5.8bn.

The idea has proved very disturbing, in particular because it reneges on the earlier EU engagement to protect all deposits up to €100k. But senior bank debt is too small (€1.7n) to provide a significant debt relief. A haircut on government debt (€4.4bn of Cypriot law bonds and €3.8bn of English law bonds) wouldn’t deliver €5.8bn either, unless a giant haircut is imposed. Still, a maturity extension would give Cyprus some breathing air. Cyprus could also sell assets, or issue bonds backed by the future string of incomes on those assets. Another idea, as we go to press, is to hit unsecured deposits (above €100k) much more heavily, while protecting secured deposits.