I warned way back in June 2008 of the dangers of a potential economic crisis in Eastern Europe in Eastern Europe: The Next Bursting Bubble? and the global economic deterioration since then has hugely increased the risks of implosion. Two weeks ago, I indicated the downside risks to Eurozone banks and the Euro itself from exposure to the region. A report this week from Moody’s, the credit rating agency, saying it could downgrade banks with subsidiaries in Eastern Europe, has sparked fresh concern over the Eurozone banking sector, leading to spiking CDS spreads for the most exposed banks such as UniCredit (45% exposure in risk-weighted assets to EE) and Swedbank (29%). The chart below, based on BIS statistics, illustrates the debt exposure of European banks to each Eastern European economy and Austria stands out as having disproportionate exposure relative to the size of its own economy, particularly to the Czech Republic, Slovakia, Romania and Hungary.

Raffeisen Bank has 54% of assets tied up in the region, while Erste has 38%. If these economies tumble, they will take Austria with them. Swedish banks are also uncomfortably exposed to the Baltic states, which are in probably the worst economic shape in the region. Currency markets are reflecting these fears. Hungary’s forint has fallen to an all-time low this week and Poland’s zloty slumped to the lowest in five years on plunging industrial output. As 50% of all loans to the private sector in Poland are in foreign currencies (generally the Euro) borrowers face a severe debt shock after the 40pc fall of the zloty against the euro since August.

Interestingly, the gap between French and German CDS spreads has narrowed abruptly for the first time since the credit crisis began as investors are ask whether Germany is going to have to pay for the rescue of Eastern and Central Europe (as well as the Eurozone periphery). Western banks that have lent $1.74 trillion to the ex-Soviet bloc, comprising about $1 trillion in foreign loans and $700bn in local currency debt through local subsidiaries. The region needs to roll over $400bn in foreign debts this year, equivalent to a third of total GDP. Despite IMF bail-outs of Latvia, Hungary, Ukraine, and Belarus, it looks like a second wave of rescues will be necessary within months. The EBRD estimates Eastern Europe may need as much as €400bn this year to refinance loans and inject fresh capital into the banking system. Austria has led efforts to create to a pan-European strategy and emergency fund (to support IMF efforts) to create a financial firebreak ahead of the looming crisis but with little success so far. In fact, the structural institutional weakness of the Eurozone is being thrown into sharp relief by this looming banking crisis.