A failure to reach an agreement on Greece's aid programme soon may drive yields on bonds issued by other euro- area countries higher, the European Central Bank (ECB) said.
"In the absence of a quick agreement on structural implementation needs, the risk of an upward adjustment of the risk premia demanded on vulnerable euro-area sovereigns could materialise," the ECB said in its twice-yearly Financial Stability Review published yesterday in Frankfurt.
"The lengthy and uncertain process of negotiations between the newly formed Greek government and its creditors" has already contributed to bouts of extreme volatility in Greek markets, it said.
Three months after taking office, the new Greek government has still failed to reach agreement with its creditors to unlock bailout funds, bringing it ever closer to default.
While ECB policy makers have claimed the region is better insulated against a disorderly Greek outcome than previously, a failure to meet payments could still create spillover effects for bond markets in neighbouring countries as well as domestic banks.
"The market cannot have fully discounted the Greek endgame because we don't know what it will be," said Steve Barrow, head of Group-of-10 strategy at Standard Bank in London.
"Contagion risks from a bad Greek outcome cannot be brushed aside but, at the same time, we tend to think that we won't get a 'bad' outcome for Greece, at least not now."
Time is running out for the Mediterranean nation to receive funding ahead of almost €1.6bn in International Monetary Fund (IMF) payments scheduled for next month, with the first transfer due June 5.
The implications of a default stretch to the nation's lenders, which are being kept afloat by emergency aid from the Greek central bank that requires ECB approval.
"A default of the Greek state to one of its external creditors will have an impact in the impairment analysis" of Greek banks, ECB Vice President Vitor Constancio said as he presented the report.
While Greek lenders are still considered solvent, "a new analysis about the impairment effect of that event on banks will have to be done", he said.
The ECB also warned yesterday that global investors could face an "abrupt reversal" of currently low yields, a development which is potentially worsened by low liquidity in secondary markets.
While banks face weak profitability, the non-bank sector contains "manifold" risk-triggers from high indebtedness.