The United Arab Emirates' central bank set up an emergency facility on Sunday to support bank liquidity in the first policy response to Dubai's debt woes that threatened to paralyze lending and derail economic recovery.

Dubai rocked the financial world on November 25 when it said it would ask creditors of Dubai World, the conglomerate behind its rapid expansion, and Nakheel, builder of its palm-shaped islands, to agree to a standstill on billions of dollars of debt as a first step to restructuring.

As a result, banks face heavy losses and the risk that fearful depositors could rush to remove cash from the system, and threatening interbank lending with the second largest Arab economy still facing a downturn this year.

It might support the market a little bit but I don't think it is enough, said Shawkut Raslan, head of brokerage at Prime Emirates brokerage.

I think some foreigners will take their money of the country and others will be afraid to put their money into these markets. The central bank policy move came late on Sunday as Dubai's Supreme Fiscal Committee gathered to prepare a statement before market open on Monday in an attempt to reassure investors.

The central bank said it opened a special additional liquidity facility linked to their current accounts at 50 basis points over 3-month Emirates interbank offered rate (EIBOR), but offered no further details.

The central bank also said the banking system was more sound and liquid than a year ago, when the global crisis ended the oil and real estate fueled boom in Arab Gulf, the world's top oil producing region.

The monetary authority said on Saturday it was closely watching events stemming from the Dubai debt crisis to ensure there is no negative impact on the UAE economy.

Before the Dubai debt crisis, the UAE economy was seen falling by 1.1 percent this year before returning to a 2.9 percent growth in 2010, a Reuters poll of analysts showed earlier this month.

PREVENTIVE MOVE

Analysts said the central bank's move was a preventive measure to avoid a possible capital flight and a run on deposits when markets reopen on Monday after a four-day holiday break.

It is important because the main concern is that there might be some panic behavior by depositors in Dubai and by bankers who want to take deposits out of the banking system, said John Sfakianakis, chief economist at Banque Saudi Fransi-Credit Agricole Group in Riyadh.

Senior bankers in Abu Dhabi, Dubai's oil-rich cousin in the UAE federation, told Reuters on Friday Abu Dhabi banks have built up an exposure to Dubai-based companies worth at least 30 percent of their loan books.

In reaction to Dubai's debt problems, Fitch Ratings has said it downgraded Dubai Bank, Tamweel and Bahrain's TAIB Bank.

It (the facility) would cover the immediate concerns related to deposits in the UAE banks, said Ghanem Nuseibeh, senior analyst at Political Capital consultancy.

It doesn't mean that lending would necessarily ease. It is no guarantee for depositors. We still don't know the extent of the UAE banks' exposure to Dubai's problems, he said.

State-run Dubai World had $59 billion of liabilities as of August, a large proportion of Dubai's total debt of $80 billion and repayment of Nakheel's $3.5 billion worth of Islamic bonds, which were originally due to mature on December 14, was widely expected by the market to be met.

Last year, the UAE finance ministry poured $6.8 billion into bank deposits, the first tranche of a $19.1 billion rescue facility it set up to help lenders weather the onslaught of the global credit crisis.

It deposited another $6.8 billion into banks in November 2008, but has not made any statements since regarding the remainder of those funds. This came after the central bank set up a $13.6 billion emergency bank facility to combat the crisis.

(Additional reporting by Dubai bureau; editing by John Irish and Mike Nesbit)

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