Dubai: The United Arab Emirates’ (UAE) 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 25 November 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 the banking system was more sound and liquid than a year ago, when the global crisis ended the oil and real estate fuelled boom in Arab Gulf.

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% this year before returning to a 2.9% growth in 2010, a Reuters poll of analysts showed earlier this month.

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 behaviour 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 told on Friday that Abu Dhabi banks have built up an exposure to Dubai-based firms worth at least 30% 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.

Dubai World had $59 billion (Rs2.76 trillion today) 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 due to mature on 14 December, was widely expected by the market to be met.