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NICOSIA (Reuters) - The embattled head of Cyprus's central bank was plunged into a new controversy on Wednesday after lawyers alleged foreign consultants employed to help with an international bailout of the country earlier this year were seeking fees of nearly 5 million euros (4.2 million pounds).
Lawyers working for the central bank said the consultants were seeking a fee based on a percentage of the amount raised from the recapitalisation of Cypriot banks in a bailout deal last March.
The fee arrangement sparked sharp criticism of central bank governor Panicos Demetriades from members of his own board, because of the controversial nature of the recapitalisation itself.
Earlier Cyprus's president said last Thursday he would press ahead in seeking the removal of Demetriados as the bank's governor after his handling of the bailout last March was sharply criticised.
Cyprus teetered on the brink of financial meltdown earlier this year after the island was forced to close a major bank, and seize savings in another bank to qualify for a 10 billion euro international bailout.
A recapitalisation of Cyprus's key lender, Bank of Cyprus, which was almost decimated by its exposure to debt-crippled Greece, was possible only after major depositors' savings were seized, a move unprecedented in the history of the euro zone debt crisis.
Central bank board members said that consultants Alvarez and Marsal, contracted by the Cypriot central bank to advise on the restructure of the island's hobbled banking system, were seeking an additional payment over their standard pay, citing a purported deal with the central bank boss which board members said they knew little about until this week.
"The whole issue is pretty outrageous," a member of the central bank board of directors told Reuters. He and other directors were only fully informed of consultants' terms on Wednesday after a report compiled by the bank's solicitors, he said.
Demetriades was already at the centre of a storm of criticism on the Mediterranean island for the way he steered Cypriot banks through the crisis, with critics pushing him to resign.
The former economics professor, under fire for most of his tenure since taking office in May 2012, said in an interview published as recently as Monday that he does not intend to resign.
In a deeply unpopular move, hundreds of Cypriots lost their life savings when funds in Laiki Bank, which folded in the 10 billion euro bailout, were lost. Savers in Bank of Cyprus BOC.CY saw 47.5 percent of deposits exceeding 100,000 euros seized to refund that bank.
The process was a painful one, but aides and Demetriades himself have in the past said the system was taking excessive risks, hinting at previous poor regulation.
Asked whether Demetriades planned to quit, a senior central bank source who asked to remain anonymous told Reuters: "There is certainly a well orchestrated, government-led, campaign that not only undermines central bank independence but is aimed at forcing the governor to resign."
"What we are witnessing in Cyprus is a dangerous precedent for a euro area country."
According to a document prepared by external lawyers of the Cypriot central bank and seen by Reuters, Alvarez and Marsal are seeking a "recapitalisation fee" of 4.75 million euros as a payment from Cypriot authorities.
A spokesperson for London-based Alvarez and Marsal, which advised the central bank on how to deal with the crisis and the restructuring of the banking system, declined comment.
A legal report seen by Reuters and compiled by central bank legal consultant Alecos Evangelou, a former Cypriot justice minister, says Alvarez and Marsal agreed with Demetriades a fee of 10 basis points 'of the total gross capital benefit into the banking system'.
An attached letter to the lawyers' report, purported to be from Alvarez and Marsal to Demetriades, makes such a reference. Demetriades has not publicly specified the terms of the arrangement.
The fee would be payable on October 31.
Bank directors were previously under the impression that any financial demands from the consultants would be on the basis of a fresh recapitalisation of funds.
But that option of fresh funds was eventually not applicable in Cyprus's case where money came from depositors which represented a "bail-in" of existing bank funds ploughed back into the system, the board member who spoke to Reuters said.
Cyprus's central bank has not denied the existence of financial demands by the consultants. In a terse statement on Wednesday, it said its lawyers believed payment of any additional fees was not justified.
Demetriades, a member of the European Central Bank governing council was appointed by Cyprus's former leftist government last year.
Last week, the island's conservative president said he was talking to government lawyers on how to get Demetriades removed from his position, claiming he was not up to the job.
The lawyers document seen by Reuters said that the consultants' requested fee should not be paid because the recapitalisation of the banks came from a 'bail-in'.
When four directors asked to meet Demetriades at a board meeting on Wednesday, he asked for a postponement until Friday, two board members said.
Additional reporting by Carmel Crimmins and Steve Slater; editing by Barry Moody and Clive McKeef