By Michele Kambas
NICOSIA (Reuters) - The governor of Cyprus's central bank failed to regulate its now-crippled banking system effectively, the island's president Nicos Anastasiades said in a letter to ECB chief Mario Draghi.
Deepening a row between the government and central bank, Anastasiades attacked Panicos Demetriades, who was appointed as governor last year, for what he said was sustaining an insolvent bank using a European Central Bank cash lifeline.
The president also said there were damaging delays in resolving problems in the banking sector, after depositors were slapped with massive losses to fund a state bailout last month.
In an April 15 letter to ECB President Draghi, a copy of which was seen by Reuters, Anastasiades speaks of "shortcomings of the Central Bank of Cyprus".
He was responding to a letter from Draghi last week in which the ECB president warned that any attempt to effectively sack Demetriades could land Cyprus in the European Court of Justice.
In the six-page letter, Anastasiades intimates that Demetriades, an academic economist appointed by the communist-led administration that lost power two months ago, was not fully independent of that government.
The recent resignations of three directors from the central bank's board "indicate that Governor Demetriades does not even enjoy the trust and the confidence of the Institution he is running," Anastasiades wrote in the letter.
The central bank declined to comment.
Demetriades, who is under growing pressure to resign over his handling of the crisis, said on Sunday he was willing to work with the government to pull the island out of its economic morass, provided the central bank's independence was respected.
Under European Union law, a governor can only be dismissed if he no longer fulfils the conditions required for the performance of his duties, or if he is guilty of serious misconduct.
Under a 10 billion euro bailout deal agreed with the European Union and International Monetary Fund last month, Cyprus must wind down Popular Bank, its second largest lender. To secure the aid, needed to avoid a default and possible euro exit, it also had to slap huge losses on uninsured deposits in the biggest Cypriot bank, Bank of Cyprus
At issue is how ECB emergency funds continued to be ploughed into Popular, also known as Laiki, even though by general admission the bank was insolvent.
The ECB's warning that it would pull the plug on emergency liquidity assistance to Cyprus's banks - for Laiki, some 9.5 billion euros - tipped Cyprus into accepting the tough rescue terms.
"I believe that the decision of Governor Demetriades not to annul the ongoing liquidity assistance provided to Laiki Bank ... with the aim of holding elections in February 2013 demonstrates his failure of effective prudential regulation and supervision of the banking system," Anastasiades wrote.
He was referring to Demetriades' comment at a news conference in March that Laiki needed to be sustained because of elections and a new government which would need to take decisions on the banking system and a bailout.
At the same briefing, Demetriades warned that the lack of a legal framework for bank resolution would have made Cyprus liable for billions in compensation to insured depositors in the event Laiki went bust, endangering the state.
Cyprus approved a bank resolution framework at the end of March which allowed Laiki to be split into a "good" and a "bad" bank. The good assets, including insured deposits under 100,000 euros were transferred to Bank of Cyprus.
Both banks had piled up on Greek government bonds and were burned when Greek debt was restructured under its own bailout.
Relations between Demetriades' predecessor at the central bank Athanasios Orphanides and the previous government were strained by its belief that Orphanides had failed to adequately supervise the banks and their expansion abroad.
Demetriades is already under scrutiny from Cypriot lawmakers over whether he supplied enough information during an investigation into the demise of Cyprus's two biggest lenders.
Parliament's ethics committee decided by majority on Tuesday to summon Demetriades to give explanations at its next meeting. If it concludes that information was withheld, it can refer the matter to the Attorney-General for further action.
(Editing by Catherine Evans)