Cyprus was looking for buyers to take over branches on the island of Tanzania-based bank FBME, which faces a US money-laundering probe, after placing the operation under adminstration.
The move by the Cyprus central bank late on Monday came in the face of historical allegations by key European Union partners that the island's once-bloated banking sector had been engaged in laundering money for Russian interests.
International creditors imposed a massive shrinking of the island's banking system in March last year, in what Cypriots widely regarded as a punitive move in return for an emergency 10 billion euro (13.5 billion dollar) bailout of state finances.
"The Central Bank of Cyprus, as supervisory authority, recommended resolution measures ... relating to the sale of operations of FBME Bank Ltd, to protect depositors," government spokesman Nicos Christodoulides said.
"The above actions demonstrate the commitment of the independent institutions of the Republic of Cyprus to safeguard financial stability," he added.
FBME, whose twin branches on the island are estimated to hold 1.7 billion euros in deposits, denies all charges of wrongdoing and has challenged the allegations from Washington.
In a statement late on Monday the Cyprus central bank said: "The resolution authority has issued a decree, under the powers conferred to it... which places the branch of FBME Bank in Cyprus under resolution."
It said the aim was to sell the assets of the two local branches of FBME, after it froze them on Friday, following US Treasury allegations that the bank was a "primary money-laundering concern".
- Mitigate the impact -
It said it hoped the central bank (CBC) taking control –- which it said it had instigated -- would be just a temporary blip in its operations.
"CBC staff members have been present at FBME Cyprus since July 18, monitoring and approving payment instructions," the bank said on Monday.
"It is intended that this will be a temporary measure to resolve the situation arising from the US Department of the Treasury announcement and will serve to mitigate the impact on the bank of the allegations that have been made,” it added.
FBME transacts over 90 percent of its global banking business through branches in Cyprus, according to Washington.
The head of the US Treasury Department's financial crimes enforcement network, Jennifer Shasky Calvery, charged last week that the bank promoted itself "on the basis of its weak anti-money-laundering controls in order to attract illicit finance business from the darkest corners of the criminal underworld".
She said the Treasury move, which effectively cuts the bank off from the US financial system, was a "necessary step to disrupt the bank's efforts".
"FBME changed its country of incorporation numerous times, partly due to its inability to adhere to regulatory requirements. It has established itself with a nominal headquarters in Tanzania," said Calvery.
She said FBME has taken active steps to evade oversight by the Cypriot regulatory authorities in the recent past.
The bank said it was making strenuous efforts to allay US concerns.
"In an effort to address the matter the Bank has instructed specialist advisors to engage with the US authorities with a view to resolving the issues and to temper the adverse impact of the announcement,” FBME said.
The management of the Cypriot economy remains under regular review by international lenders following the 2013 bailout which imposed a swinging austerity programme as well as the closure of the island's second largest lender and an unprecedented levy on deposits.
German allegations that the Cyprus banking system was a "casino" for Russians trying to convert "black rubles" into "white euros" were widely seen by Cypriots as a key motive for the most punitive bailout so far of any eurozone economy.