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One of the biggest threats to financial stability in the eurozone comes from the region’s exposure to central and eastern European banks.

Indeed, more than 80% of emerging Europe bank assets are owned by western European banks. This was fine during times of easy credit when the region’s economies were growing strongly. However, widening spreads and a painful slowdown in growth now point to a serious risk to these exposures as non-performing loans may reach above 25%.

- Peter Attard Montalto, Emerging Europe Economists, Nomura

When I woke up Tuesday morning, I was surprised to see the Dow off almost 300 points. As I tried to figure out why, my usual sources didn’t really supply convincing explanations. In fact, the U.S. media (WSJ, CNBC) still hasn’t done a good job of explaining yesterday's route.

It took me a while, but eventually I figured out that the cause of this was a report, issued in London, by Moody’s titled: “West European ownership of East European banks during financial and macroeconomic stress.” The European media is all over this and a little time at FT.com made Tuesday’s action intelligible to me.

In the report, Moody’s described the nightmare in Eastern Europe and the massive exposure to it of Western European banks. According to Nomura’s Mr. Montalto, 80% of emerging Europe’s bank assets are owned by Western European banks.

According to Moody’s, Eurozone banks have $1.5 trillion in liabilities in Central and Eastern Europe with 84% concentrated in six countries: Austria, Italy, France, Belgium, Germany and Sweden. The Moody’s report described the crumbling economies and deteriorating loan quality in Eastern Europe. They highlighted five large Western European banks with a lot of exposure: Raiffeisen (OTC:RAIFF), Erste Bank (OTCPK:EBKDY), Societe Generale (OTCPK:SCGLY), UniCredit (OTCPK:UNCFF) and KBC [KBC/BR].

This resulted in a huge sell-off in European banks, which infected the entire European market. U.S. markets also sold off when they opened Tuesday morning.

Adding to the nightmare is the fact that many loans made by Eastern European banks were apparently made in Euros and Swiss francs. As the local currencies tank, and the locals who took out the loans conduct their lives in the local currencies, it becomes harder and harder for them to pay back the euro and Swiss franc denominated loans. “Local currency depreciation is a major risk to East Europe banks,” Moody’s analysts wrote in their report.

On Sunday, Ambrose Evans-Pritchard gave an overview of the impending crisis in The Telegraph: “Failure to save East Europe will lead to worldwide meltdown.”

This could be EUROPE’S SUBPRIME.

Source: Did Eastern European Bank Exposure Trigger Tuesday's Sell-Off?