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A broker watches a screen displaying financial information about turmoil in the Portuguese stock market and the sharp fall in Portuguese bank Banco Espirito Santo shares, in a trading room of a Portuguese bank, in Lisbon, Thursday, July 10, 2014. Share prices on the Lisbon stock exchange fell more than 4 percent and Portugal's bond yields ticked higher amid growing concern about the health of one of the country's largest financial groups.

Francisco Seco/AP

The euro zone recovery was just starting to seem like smooth sailing. How quickly the fears came roaring back.

For more than a year the euro zone financial system has barely been talked about, and any flare-ups, like the bank run in Cyprus, were quickly forgotten. Then came Thursday's panic.

After plummeting more than 50 per cent since the start of April, Banco Espirito Santo, Portugal's second largest bank by assets lost 17 per cent Thursday, prompting the country's regulator to halt the shares. Immediately there were fears that a new European banking crisis was brewing and stock markets across the continent took a hit. Without knowing any facts, it's easy to assume the new woes are contagious to other lenders.

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Relax. Not only has the core issue been known about since December, BES itself may be in good shape; it's the parent company of its major shareholder that looks wobbly, for now, and its troubles present less of a threat to the financial system than a potential bank collapse.

Here's how the corporate structure works: Espirito Santo International SA is a large, diversified holding company that owns everything from a real estate portfolio to a hotel chain. ESI owns one-third of Espirito Santo Financial Group, and ESFG is the main shareholder of BES.

Dating back to December, accounting experts scrutinized the way in which ESI had raised money to help keep itself afloat during the worst of the crisis. It appeared everything the company did was legal, but there were concerns ESI sold preferred shares to retail investors and understated the risks of buying these investments.

Concerned, the Portuguese central bank ordered an audit of ESI, and determined that the parent company was in "serious financial condition." That's old news. But the worries were exacerbated this week when ESI delayed payments on some short-term debt.

The latest updates matter because it could spell serious trouble for the Portuguese economy. ESI is a massive holding company, and if its woes hurt business confidence, BES, the bank, could suffer even more loan losses. Last year BES lost €517-million ($749-million), largely because of credit provisions.

However, we're still waiting for proof that the bank itself is in dire financial condition. All three of Portugal's large banks have tier one common equity ratios that please the powers that be – BES's is 9.8 per cent – and BES also did not need a government bailout during the euro crisis.

The drama is admittedly messy because BES's chief executive officer sat on the board of parent company ESI, so who knows how the inner dealings played out. Maybe BES lent boatlods of money to ESI.

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But at this point investors are panicking simply because clarity is hard to come by. BES may come out of this bruised but alive, or any woes could be contained to the holding company itself, rather than spreading across Europe.

We also can't forget that the MSCI European banks index has soared 70 per cent from its 2011 low. Investors have been riding high on euphoria, happy to think the worst was behind them. That never made any sense. For now, call this a correction that was long overdue.

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