UPDATE 2-S&P cuts Cyprus rating on banks' Greece exposure
* Rating agency puts new 'A' rating on negative outlook
* Sees public debt rising to 79 pct/GDP in 2011
(Adds Finance Minister)
NICOSIA, Nov 16 (Reuters) - Standard and Poor's downgraded its sovereign rating of Cyprus by one notch to A with a negative outlook on Tuesday, citing concerns of a spillover effect from Cypriot banks' exposure to debt-ridden Greece.
S&P, which warned Cyprus of a possible downgrade in June, said its action reflected "increased vulnerabilities from embedded credit risk of the Cypriot financial system's external assets and domestic loan book, and the impact these could ultimately have on public finances".
Although expected on the back of deteriorating public finances, Tuesday's S&P note made special mention of banking sector liabilities and exposure to Greece.
In the past decade, it said, the Cypriot financial system's exposure to Greek customers and securities of the Greek government and corporations had grown to more than double Cyprus's GDP.
"Although the system reports high capital levels, the sheer size of Cyprus's financial centre poses funding risks in our view," S&P said.
If it saw risks for the Cypriot financial system growing, as evidenced by further downgrades of Greece or higher rates of non-performing loans, the ratings of Cyprus would likely come under further downward pressure.
Cypriot finance minister Charilaos Stavrakis insisted that local banks were well capitalised and able to absorb any shocks from Greece. However he did acknowledge that local banks had "some" exposure to Greece.
"It is clear now that they (S&P) worry less about public finances, and much more about the perceptive risks of the Cypriot banking system," he said.
Asked about bank exposure to Greece, he said: "I have seen the numbers myself and there is some exposure to Greek government bonds ... even however in the very theoretical scenario that there was a problem with Greece, the banks of Cyprus have solid capitalisation and could absorb such losses."
The relative size of domestic credit was among the highest in Europe, at 280 percent of GDP. Most of that was collateralised by property assets, which had seen a decline in value in the last two years, the agency said.
Cyprus entered the European Union's excessive deficit procedure in 2010 after pushing up its deficit to 5.96 percent of GDP in 2009. It will reach an estimated 5.5 percent this year.
Stavrakis said the downgrade was not expected to have any immediate impact on borrowing costs. "Fortunately the government covered its needs in foreign borrowing for the next several months and this downgrade will not have an immediate impact on the Cypriot taxpayer," Stavrakis said.
It raised one billion euros in a benchmark 5-year bond at the end of October. (Writing by Michele Kambas, editing by Mike Peacock)
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