The spectre of “Financial Crisis 2” continued to loom over global markets yesterday after Dubai’s revelation that it may not be able to meet its debt obligations.

Stock markets in Asia and the United States fell sharply while the dollar and Japanese yen rose as investors shifted their money to their perceived safety.

UK banks were also revealed to be the biggest lenders to the United Arab Emirates, which includes Dubai, with more than $50 billion owed by the Gulf state’s residents.

In another blow to the beleaguered UK banking sector, the Royal Bank of Scotland emerged as the largest single loan-arranger to Dubai World, the state-owned conglomerate that sparked this latest financial crisis when it sought a standstill on its debt repayments on Wednesday.

RBS, which is owned by British taxpayers, has arranged loans worth up to $2.3 billion to Dubai World.

The Financial Services Authority, the regulator, is understood to have sought assurances from banks that their exposure to Dubai will not threaten their financial strength. The FSA said it would continue to keep a close eye on the situation.

Dubai World, which owns a range of assets including the Turnberry golf club in southwest Scotland, sparked panic when it asked for the debt standstill. The company has liabilities of $60 billion and its Nakheel property division, which built the Palm Jumeirah development where the footballers David Beckham and Michael Owen own houses, was due to repay a $3.5 billion bond next month.

The standstill has raised the prospect that Dubai World and, by extension, the government of Dubai might default on their debt.

As the drama in Dubai has unfolded, financial traders have had to come to terms with the possibility that other countries may also struggle to repay their ballooning debts in coming months.

This has sparked fears that we may be entering another phase in the financial crisis should lenders take fright and hold on to their cash rather than lend it, leading to another seizure in the world economy.

“If you look to government balance sheets around the world you’ll find plenty of potential banana skins,” said Jim Reid, strategist at Deutsche Bank. “Given the nature of this crisis the probability of further sovereign events remains elevated.”

Bank of America analysts also warned that Dubai’s crisis could trigger a wider problem as countries default on their debts, resulting in a “major step back” in the global economic recovery. Another analyst dubbed this scenario “Financial Crisis 2”.

One indication of the fear among investors has been the rise in credit default swaps (CDS), which is the cost of insurance against a debtor defaulting.

Dubai’s CDSs rose by 134 basis points yesterday to 675, meaning insuring $10 million of the emirate’s debt would cost $675,000. This is just $30,000 short of the amount Lehman Brothers’ CDSs were trading for just before the bank went bust last year. The CDSs for countries including Malaysia, Thailand, Latvia and Hungary also all rose yesterday.

Gordon Brown attempted to calm growing panic over the threat to a global economic recovery. Speaking at a Commonwealth summit in Port of Spain, Trinidad, Mr Brown said: “While it is a setback, I think we will find it is not on the scale of previous problems we have dealt with. I think global recovery has depended on monetary action and fiscal stimulus.”

British banks are among the most vulnerable to a potential Dubai World debt default, partly because of the strong historical ties between the countries — Dubai was a British protectorate until 1971.

Goldman Sachs estimated that HSBC, Britain’s largest bank, could lose up to $611 million if Dubai World defaulted. The bank has a total of $15.9 billion loaned to the UAE.

Standard Chartered, another British bank, could lose up to $177 million if Dubai World defaults, while RBS is the biggest potential loser with an exposure up to $2.3 billion.

More than £14 billion was written off the value of British banks on Thursday but the FTSE 100 regained momentum yesterday and rose 51.6 points, or 1 per cent, to 5,245.73.

However, Asian stock markets fell heavily yesterday and the Dow Jones Industrial Average in New York was also down 133.24 points, or 1.3 per cent, to 10,331.16.

The yen rose to a 14-year high and the US dollar was also up against many currencies as investors fled to these safe havens. Meanwhile, commodities fell as Dubai’s difficulties raised the prospect of the global economic recovery stalling. Oil was down $2.20 to $75.76 and other commodities such as copper were also down.

Dubai has grown rapidly in recent years but this has been fuelled by debt as the emirate has borrowed heavily to build property and buy overseas assets, including the QE2, which has been converted into a hotel.

Dubai is estimated to have total debts of $88 billion but investors had assumed that this would be manageable because, if worst came to worst, the emirate could be bailed out by Abu Dhabi, its oil-rich neighbour.

Abu Dhabi’s sovereign wealth funds have reserves estimated at over $700 billion, so a bailout of Dubai is easily within its reach. This implied guarantee has helped calm investor fears over Dubai’s debt burden in the past but Abu Dhabi’s decision not to help Dubai World with its Nakheel bond hints at a possible breakdown in relations between the two emirates.

Sources in Abu Dhabi suggested that it might be waiting for Dubai to falter before stepping in with a rescue package, securing assets for a fraction of their current cost.

Alternatively, Dubai may be on its own — an outcome that could cost British banks dearly. It may also be forced into a firesale of its assets, which include a 20 per cent stake in Cirque de Soliel, the circus troupe.

Until the diplomatic situation between Dubai and its potential white-knight neighbour becomes clearer, the threat of Dubai’s debt problems spreading to other countries will continue to stalk global markets.

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive