World leaders expressed confidence in the global economic recovery on Friday despite fears about a debt default by Gulf emirate Dubai, while major banks played down their exposure to the debt.

Stocks from Tokyo to New York were haunted by concern that banks were exposed to state companies in Dubai, whose rise from a desert backwater into the business hub of the world's top oil exporting area lured expatriate cash and executives.

The crisis began on Wednesday when Dubai, part of the United Arab Emirates federation, asked to delay payment on billions of dollars of debt issued by conglomerate Dubai World and its main property subsidiary Nakheel, developer of three palm shaped islands that once attracted celebrities and the super-rich.

While it is a setback, I think we will find it is not on the scale of previous problems we have dealt with, British Prime Minister Brown told reporters in Port of Spain.

The world financial system is stronger now and able to deal with the problems that arise.

French Prime Minister Francois Fillon said the Gulf had the resources to ensure the world would not sink into a second round of turmoil, but Russian premier Vladimir Putin said the saga showed how hard it is to shake off a crisis that has lasted two years.

In the United States, administration officials said the Treasury Department was closely monitoring the situation in Dubai, while Canadian Finance Minister Jim Flaherty said the Group of Seven industrialized nations has had discussions about Dubai's credit issues and was monitoring consequences.

Japanese Finance Minister Hirohisa Fujii raised the prospect of a G7 joint statement on currencies in Tokyo after the Dubai debt worries pushed the Japanese yen currency to a new 14-year high against the dollar. But no such statement has been issued and the yen retreated from its earlier highs.

DUBAI DEBT $80 BILLION

Dubai World had $59 billion of liabilities as of August, most of Dubai's total debt of $80 billion. International banks' exposure related to Dubai World could reach $12 billion in syndicated and bilateral loans, banking sources told Thomson Reuters LPC.

But the numbers pale in comparison to the $2.8 trillion in writedowns the International Monetary Fund estimates U.S. and European lenders will have made between 2007 and 2010.

The events in Dubai in recent days are one of the hiccups if you like, one of the difficulties, which affirms that we were right to highlight the uncertainty ahead of us and that the road ahead could be a bumpy one, European Central Bank Governing Council member Athanasios Orphanides said.

Analysts expect Dubai to receive financial support from Abu Dhabi -- a fellow member of the UAE and home to most of its oil -- though it may have to abandon an economic model focused on developing swathes of desert with foreign money and labor.

But the prospect of a bailout did little to allay concerns among investors, already worried the global economy may not be recovering quickly enough to justify a near doubling of prices for emerging market stocks and many commodities since March.

WORLD MARKETS WOBBLE FOR SECOND DAY

The fears of a possible Dubai debt default rippled through world markets for a second day on Friday, but the exodus from stocks and the rush to the safe-haven U.S. dollar and bonds slowed as investors discounted the possibility of contagion in other emerging markets.

U.S. stocks fell more than 1.0 percent on Friday, the first day of trading after the Thanksgiving Day holiday on Thursday, but European stocks rebounded a day after falling 3.0 percent on the Dubai news, which particularly hit bank stocks.

What we've seen is that once the dust settles, some of the markets that were hardest hit have rebounded, said David Katz, chief investment officer at Matrix Asset Advisors in New York. It's a scare to the markets, but the U.S. has less exposure to Dubai than Middle Eastern and European banks.

The MSCI world equity index fell 1.0 percent, posting its second consecutive weekly loss.

The MSCI since October has had trouble extending the rally that began in March as investors have raced to lock in gains ahead of year-end accounting. The index is still up about 70 percent since early March.

The Dubai announcement served as a catalyst to an overdue correction to markets whose valuations have outpaced economic and corporate realities, Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. told Reuters.

BANK EXPOSURE

The Dubai news raised fears that some major banks could face yet more writedowns in addition to those already triggered by the global financial crisis in 2008.

U.S. bank debt and the broader corporate bond market sold off on Friday. The costs to insure the debt of some big U.S. banks against potential default rose between 10 and 20 basis points.

But HSBC, Europe's biggest bank and the one with more loan exposure to the UAE than any other at around $15.9 billion, said it was not concerned.

JP Morgan said it was less concerned about global banks' direct exposure to Dubai World and was not worried about Abu Dhabi, which is sitting on hundreds of billions of dollars.

We are more concerned about the spillover effect within the UAE, it said in a note. It remains unclear if the Dubai government will support the liabilities of government related entities.

Lenders in Abu Dhabi have lent heavily to Dubai and could suffer.

The costs to insure Dubai government debt against potential default climbed. Five-year credit default swaps widened by about 145 basis points from late Thursday, to 688 basis points, according to CMA DataVision. Dubai CDS have more than doubled since the announcement on Wednesday.

The debt crisis in Dubai also pushed up debt insurance costs for other sovereigns in the Gulf, a wealthy region Western firms had turned to for help at the height of the credit crunch, and at some major U.S. banks.

Analysts said the timing of the news on the eve of the Muslim Eid al-Adha holiday, the lack of prior communication with investors, and the scant details given on the plans dented Dubai's credibility.

The way the announcement was made, including its timing has caused damage to Dubai's credibility, Ghanem Nuseibah, senior analyst at Political Capital Policy Research & Consulting Institute. This will take a very long time to repair.

(Writing by Lin Noueihed and Clive McKeef, reporting by Martina Fuchs and Enji Kiwan in Dubai, Adrian Croft, Sujata Rao, Steve Slater, Atul Prakash, Caroline Cohn in London, and David Lawder in Washington DC and Al Yoon, John Parry in New York and John McCrank in Toronto; Editing by Mike Peacock/Ruth Pitchford/Chizu Nomiyama)