The euro-region’s debt crisis has affected financial markets globally, pushing up borrowing costs for banks and triggering sell-offs in emerging-market assets, according to the Bank for International Settlements.

Gross debt issuance in international markets dropped to $1.66 trillion in the three months through September, the lowest since 2005 as buyers demanded higher compensation for risk, the BIS said in its Quarterly Review. Investors withdrew more than $25 billion from emerging-market funds in August and September as they sought to either reduce risk or sent money home to repair their balance sheets, it said.

“News on the euro-area sovereign debt crisis drove most developments in global financial markets between early September and the beginning of December,” the report said. “Financial institutions with direct exposure to euro-area sovereigns saw their costs and access to funding deteriorate.”

The problem was exacerbated by a deteriorating economic outlook, the BIS said. The European Central Bank on Dec. 8 revised down its growth forecast for next year to a range of minus 0.4 percent to plus 1.0 percent, from 0.4 percent to 2.2 percent previously.

“A run of poor data and policy uncertainty put pressure on bonds issued by euro-area sovereigns with high debt burdens,” the bank said. “Greek and Portuguese bond yields rose further, reflecting difficulties in meeting fiscal targets with their economies mired in recession.”

The BIS was formed in 1930 and acts as a central bank for the world’s monetary authorities.

Bank Solvency

The debt crisis raised concern that financial institutions will be unable to raise funds as lenders became cautious about their solvency due to their holdings of euro-region government bonds, the BIS said, noting Franco-Belgian bank Dexia SA and MF Global Holdings Ltd. as examples.

BNP Paribas SA, Societe Generale SA and Credit Agricole SA had their credit ratings cut on Dec. 9 by Moody’s Investors Service, which cited funding constraints and deteriorating economic conditions amid Europe’s debt crisis.

Banks’ deteriorating balance sheets and rising funding costs in turn undermined their market-making activities, increasing market price swings as liquidity declined, the BIS said.

Banks were also forced to pass on the burden to their corporate and retail borrowers. The average interest rate on all new loans from European banks to companies increased by 1 percentage point in the year to September while banks in Greece and Portugal raised interest rates by about 2 percentage points, according to the BIS.

Central Bank Action

Six central banks, led by the Federal Reserve, agreed on Nov. 30 to make it cheaper for banks to borrow dollars in emergencies in a global effort to ease Europe’s sovereign debt crisis. They also created temporary bilateral swaps programs so funding can be provided in any of the currencies.

“The wide range of liquidity measures bought time but did not alleviate banks’ medium-term funding challenges, underscoring the current focus on plans to strengthen the banking sector,” the BIS said.