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Debt default is nothing new in the world of finance after the global financial crisis set in. The US and European lenders would have written off trillions of dollars as bad debts between 2007 and 2009.
But when Dubai World sought to restructure part of its estimated $59 billion in debts, it became termed as the next biggest financial debacle.
The announcement was compared to everything from Argentina's default in 2002 to Lehman Brothers' collapse last year. Stock markets around the world dropped sharply as investors tried to figure out what it all meant.
With the potential for a default on the debt, rating agencies including Moody's and Standard and Poor's immediately stepped in and downgraded several Dubai state entities. The cost of insuring Dubai debt also soared, as did protection for Abu Dhabi debt.
The UAE's central bank, meanwhile, pledged to support national financial institutions and local branches of foreign banks with increased liquidity. But finance officials in Dubai have warned that the government was not responsible for the company's debt.
The reactions to the debt issue have been varied. Finance critic Max Keiser, who predicted the collapse of Dubai earlier this year, warns that the debt announcements mark the beginning of 'phase two' in the global economic crisis.
Though the amount of money involved was not excessively large by proportion, Keiser explains that after the massive losses already weathered by European banks, all new write-offs take on added significance, cutting into 'the bone of the global financial system'.
Not all are as pessimistic. Financial experts say, although the situation at Dubai World does not appear to pose the kind of systemic risk that created past crises, either the one that erupted after the bankruptcy of Lehman Brothers last year or the previous debt crises in Asia or Latin America, it does not mean that it cannot trigger a broader crisis of confidence in emerging markets inflated by cheap dollars.
Dubai World and the companies it controls have between them $59 billion in liabilities. But that number includes a lot of obligations that are not conventional debts, analysts say.
Excluding these, Dubai has a much more manageable $23.8 billion in debts, according to Deutsche Bank's estimates. Of that, only about $5 billion is owed directly by Dubai World. Also, not all of the remaining $18.8 billion is affected by debt postponement: Dubai has already said that ports operator DP World and the Jebel Ali Free Zone Authority (Jafza) will not be included in the debt restructuring.
Another misconception is that if Dubai World misses the December 14 Nakheel payment, banks to which it owes money will suffer a debilitating blow.
Most of the banks that lent Dubai World money most likely started provisioning against it at the height of the crisis earlier this year. The same goes for owners of Nakheel's bonds.
Many of them undoubtedly bought those bonds when they were selling at steep discounts and are even now sitting on profits.
Albeit, what could be in store for Dubai World from its creditors?
In the case of Dubai World, banks and other creditors have the option of rejecting the standstill and trying to enforce security over the holding company's assets - which include the QE2 cruise liner and port operator DP World. But the legal process will be drawn out and recovery values unpredictable.
International creditors may struggle to persuade local banks to reject the standstill.
That would suggest an out of court restructuring is more likely, and that banks will push for the best terms they can get.
Much will depend on how the proposed standstill is structured, which is still not certain. Lenders may be unwilling to sign to an agreement that forces them to defer interest, because that would make it more likely that they will have to take additional bad debt provisions before the end of the year.
But while the banks may be prepared to take some pain or extend their debt, they will want something in return from Dubai and its wealthier neighbours.
However, Dubai will be able to manage the current debt problem but more efforts are needed to ensure recovery in its real estate and other sectors in the long term, the Economist Intelligence Unit (EIU) says.
Analysts in the UAE support that view and say they believed the debt problem would have little impact on UAE banks given their massive resources and a sharp increase in their loan-loss provisions this year.
Nevertheless, there will be long-term economic consequences. Real estate and leisure-based tourism development will struggle for growth for some time to come and prospects for the financial services sector are not good.
How will it affect Bahrain?
Profit at Bahraini banks will likely be affected by Dubai's debt woes due to provisions booked on their exposure and hits on their investment portfolios.
A large chunk of Dubai's debt is related to billions of investments in property it made before its real estate bubble burst late last year.
Banks in Bahrain are likely to have some sort of exposure to Dubai, so profitability will be affected depending on the specific exposure of each bank, says Suleman Soorani, a banking analyst at Bahrain-based Sico Investment Bank.
The extent depends on the level of provisioning the central bank will require banks to book and which loans they'll have to book as NPLs (non-performing loans), he adds.
