The parliament in Cyprus has rejected legislation bringing its co-operative banks under the direct supervision of the Central Bank.
The condition is part of the bailout programme agreed with international lenders earlier this year.
Approval of the measure is said to be crucial to Cyprus receiving the second installment of its bailout, worth €1.5 billion.
Earlier this week a draft report from the European Commission said Cyprus is successfully carrying out the reforms necessary under its €10 billion bailout programme and will get the next tranche of financial help as planned.
Inspectors from the European Commission, the European Central Bank and the International Monetary Fund visited Cyprus in the second half of July to assess progress on strengthening public finances.
The island economy, hit hard by the restructuring of its once oversized banking sector, is expected to contract 8.7% this year after shrinking 2.4% in 2012. It is expected to contract a further 3.9% in 2014 and will only start to grow again in 2015, by a forecast 1.1%.
Nicosia is expected to have a budget deficit of 6.5% of GDP this year, up from 6.3% last year. It is forecast to rise to 8.4% in 2014 before falling to 6.3% again in 2015 and 2.9% in 2016.
The report said there were so far no changes to the key macro-economic and fiscal forecasts which could change the initial assumption that Cypriot debt would peak at around 127% of GDP in 2015 and decline to 123% in 2016.