Standard & Poor's said today it had lowered its long-term sovereign debt rating for Cyprus from A+ to A, with a negative outlook, expressing concerns about the government's potential exposure to credit risks in the disproportionately large banking sector.

Regarding the banks, it noted their large exposure to struggling Greece and the island's own relatively very high levels of domestic credit.

"The downgrade reflects our opinion of 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," said Standard & Poor's credit analyst Benjamin Young.

The agency said after a decade of rapid expansion, the banks' balance sheets now exceeded 700 percent of GDP, including both domestic and foreign institution.

It said the total exposure to Greek customers, and securities of the Greek government and corporations, had grown to more than 250 percent of GDP.

It said that at 280 percent of GDP, the relative size of domestic credit in Cyprus was also among the highest in Europe. Much of that is collateralised with property assets, which, overall, had suffered a decline in value over the past two years.

"Although the system reports high capital levels, the sheer size of Cyprus's financial centre poses funding risks in our view," S&P said.

"The negative outlook reflects our opinion of the risks that the large financial sector contingent liabilities could migrate to the government's balance sheet," said Young.

The agency noted that, as well as that, the government had already incurred direct exposure through a three billion euro note issue, equivalent to 17 percent of GDP.

"This financial system support has added to the fiscal pressure the government already incurred from the global recession, in our view," S&P said.

It noted new revenue-raising measures in the pipeline, including excise duties on petroleum and tobacco and the planned introduction of a five percent VAT rate on foodstuffs and pharmaceuticals, but said it expected the island's 2010 deficit to remain largely unchanged at six percent of GDP.

"Although we believe that the passing of the 2011 budget ... will be sufficient to achieve the government's target of a 4.5 percent of GDP deficit, we forecast that the government's debt-to-GDP ratio will peak at 79 percent in 2011, compared with 48 percent at year-end 2008," it said.

At the end of October, Moody's rating agency said the outlook for the banking system in Cyprus was "negative" due to slow growth and repercussions from the financial crisis in Greece.