Greek contagion risks may be higher than you think

A perception in financial markets that Greece exiting the euro zone would have limited knock-on effects is misguided, some analysts say.

Euro zone officials meet in Latvia this week to discuss a rescue deal between Greece and its creditors amid growing talk that time is running out for Athens to avoid defaulting on its debt and being ejected from the 19-member euro zone.

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"UBS does not believe, as its base case that Greece, will leave the euro," Paul Donovan, UBS global economist, said in a video published by the bank's research team.

"However, there seems to be a belief in financial markets that if Greece were to be forced from the euro area it should be regarded as an isolated incident," he said. "This belief, seems to us, to be dangerous."

Read MoreGreece facing 'Lehman moment' as debt costs soar

Donovan said that the view that Greek problems were distinct from the rest of the euro zone was reflected in recent online search patterns: Searches on Google for the term "Grexit" had soared, while those for "euro crisis" or "euro collapse" had not, even though they did during the 2012 euro zone debt crisis.

In the latest crisis, government bond yields in peripheral euro zone countries—in the past viewed as most vulnerable to any Greek contagion—have not followed Greek bond yields higher.

Greek bond yields have risen sharply this week, reflecting the greater risk attached to holding them. Greece's benchmark 10-year bond yielded over 13 percent on Tuesday, well above Spain's 10-year yield at 1.48 percent and Portuguese yields at 2.12 percent.

Although this can partly be explained by the European Central Bank's (ECB) massive monetary stimulus program, which is putting downward pressure on yields, it also reflects diminished contagion fears.

"I don't get the sense that there is a widespread view that if a deal is not made and Greece exits the euro zone, you would have this massive contagion effect," Ben White, Politico's chief economic correspondent, told CNBC on Monday.

Cash over deposits

UBS' Donovan said any contagion from a Grexit would come from the banking system. He said that if Greece did leave the euro area, any money in Greek banks would be redenominated into a new currency, which would probably plunge in value, distressing depositors.

Read MoreECB staff mulls plans to curtail bank funding

Depositors in other countries may think their holdings are safe, since their country is not going to leave the euro zone--or they may decide to avoid any risk and withdraw their savings, Donovan said.

"Why take the risk that your country probably won't leave the euro, if it's a relatively simple operation to withdraw your savings and hold them in cash?" Donovan asked.

"A euro held as cash today is a euro tomorrow," he said. "A euro held in a bank account today may be an entirely different currency tomorrow, if the irrevocable monetary union has been revoked. Investors are thus likely to choose cash over deposits."

Hold on

Antonio Roldan Mones, southern Europe analyst at Eurasia Group, said there were valid reasons why financial markets now viewed the contagion risk from a Greek crisis differently to a few years ago.

In particular, the ECB has established institutions to come to the aid of any member state in trouble, it has a 1 trillion euro ($1.1 trillion) monetary stimulus program in place and smaller economies such as Portugal and Spain have taken steps to strengthen their banking system, Mones said.

"But it's true once you open the possibility of exit, once the irrevocability clause is no longer credible, then if there are problems – a populist party comes to power or the growth numbers go down – then the possibility of exit is there and markets may start betting on it," Roldan Mones told CNBC.

"The other issue is that there are still structural challenges in some of these countries," he added. "Portugal still has a large debt-to-GDP ratio of around 130 percent, growth is better than it was but still weak; there are still problems in the banking sector, so I wouldn't discount the possibility of contagion if things go south in Greece."

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