By Kathleen Brooks: Research Director UK

Back in June, there was a real fear that Greece might default. It was relying on its next tranche of bailout funds to pay its creditors, yet the IMF and some Eurozone economies were not forthcoming with the cash. This led to frantic efforts by Athens to slash its budget deficit at an even faster pace and a vote to pass the measure went down to the wire. If the cuts hadn't been passed, Greece wouldn't have received its next portion of funds sparking the first default by a developed economy in more than 50 years.

While anti-cuts protests raged in Athens, the euro wobbled, however it still managed to stay above 1.4000 versus the U.S. dollar. The story ends when the budget cuts were passed by the Greek Parliament, the bailout funds were released and a financial Armageddon was avoided allowing the euro to continue its up-ward march versus the dollar (although it fared less well versus the Swiss franc).

But the story isn't over. In September, the next tranche of funds is due and Greece could have an even bigger battle on its hands. This time the problem lies with other member states. Finland, where there is strong political resistance to bailouts, has secured approximately EUR1 billion of collateral in return for its tranche of the second bailout. And there are signs that other member states want to follow suit, including the Netherlands and Austria.

On the surface, these collateral agreements sound reasonable: the primarily fiscally secure Northern European countries that lent money to a risky debtor like Greece want to protect their investment. However, in reality these collateral agreements may exacerbate the situation. After Finland's announcement, Moody's, the credit rating agency, said that the collateral agreements could risk delaying the next tranche of bailout funds that come due next month, which would be credit negative for the beleaguered southern European state. This is worrying since Greece is already at the deeper end of junk status; Standard & Poor's reduced Greece's rating to CC, with a negative outlook earlier in the summer. Greece is hanging on to "junk" status by the skin of its teeth and another battle to win bailout funds would most likely lead to a downgrade to default.

The word default sends shivers down the spine of the market, so one could imagine that a default would cause a flight from risk and some major volatility. It's not only Greece that would cause this volatility, it is the message it sends. If Eurozone heavyweights would see other member states default rather than give them loans without collateral then what message does that give? Could Italy be next, how about France - two other highly indebted members?

The risks of letting Greece go down the drain are vast and far-reaching. We are in unchartered territory right now - we don't know what a default would mean for the future of the Eurozone, whether that member would have to leave, or if the default of one would dent the reputation of the whole. Is the team only as strong as its weakest member?

These are unanswered questions and have the potential to shake the entire financial universe to its core. This wouldn't be localized either. If a sovereign collapsed, this would hit the banks, obviously Greek banks but French and German banks are also exposed to Greek debt. We have already seen inter-bank lending rates rise for Europe's banking sector as fears grow about the strength of their capital buffers, especially relative to some of their U.S. counterparts. A Greek default could shatter the remaining confidence in Europe's financial institutions. Banks are the glue that holds economies together, if they become dysfunctional in Europe then this could cause a prolonged downturn and a credit crunch that may even eclipse 2008.

But is this likely to happen? Now that Finland has received its collateral request it opens the floodgates for others. European high command cannot stop another member from demanding the same as that would be unfair. This makes a temporary stop-gap measure next month more likely as collateral agreements, etcetera get hammered out.

Added to this, Europe's leaders have tended to wait until the 11th hour to provide the support necessary for Europe's most troubled states, so we wouldn't rule out another wrangle for funds. After the July summit, Greece received a promise of more financial support in return for greater fiscal consolidation efforts. Although its budget deficit has fallen in recent months, it remains higher than last year. If the pace of progress is deemed to be too slow, we may see a replay of June's crisis of confidence, although this time, with real consequences like a potential downgrade to D or default status.

For most of this year, the euro has been fairly well supported against the dollar. But we shall have to wait and see if another bout of stress could hurt the single currency in a more profound way. One thing is for sure, we might be set for another volatile autumn.

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