Eurozone debt crisis 'most serious and immediate' threat to UK

Eurozone debt crisis 'most serious and immediate' threat to UK
The debt crisis enveloping the eurozone is "the most serious and immediate" threat to the British economy, according to the first report from the UK's Financial Policy Committee.

By Harry Wilson


Sir Mervyn King, Governor of the Bank of England and one of the founder members of the Committee, said the worsening financial problems of several European countries risked damaging British banks, even if they had little or no exposure to their indebted economies.

"Experience has shown that contagion can spread through financial markets especially when there is uncertainty about the precise location of exposures.

"A UK bank could have lent to a bank that itself had lent to a bank in turn was exposed to sovereign risk," said Sir Mervyn.

In a wide-ranging 50-page report, the FPC was clear that the Greek debt crisis could spread and risked hurting the euro's largest members, France and Germany, in turn setting off a wider crisis that risked embroiling the UK financial system.

While British banks have little direct exposure to Greece their combined lending to France and Germany is equal to about 130pc of their total core Tier 1 capital and of this about half represents lending to French and German banks that were among the biggest lenders to peripheral eurozone countries like Greece.

Asked whether the situation could escalate in a similar way to the market crash following the collapse of Lehman Brothers in September 2008, Sir Mervyn dismissed the comparision, but warned that "uncertainty" about exposures that banks held on their balance sheets could lead to a new funding crunch.

"It is the sheer uncertainty of knowing which direction it will go that creates the risk. No more than that," he said.

As part of its report, the FPC made six recommendations that it hopes will prevent UK banks from being brought to the point of collapse like they were three years ago.

The FPC said the Financial Services Authority must gather more information on the sovereign debt and bank exposures of Britain's largest lenders to give comfort to investors wary of the risks held on their balance sheets.

In addition, the FPC said banks must take advantage of good market conditions to build up their loss-bearing capital to cope with market downturns and that the FSA should regularly check up on them to ensure they were doing so.

Lord Turner, the chairman of the FSA, and Hector Sants, the regulator's chief executive, are among the five founding members of the FPC.

"We're fully supportive of implementing all these recommendations of the Committee," said Mr Sants, who is due to become deputy Governor of the Bank of England when he takes control of the new Prudential Regulation Authority that is set to replace the FSA as the lead regulator of UK banks at the end of next year.

British banks have already been cutting their borrowing to eurozone banks as fears have grown over the impact a Greek default would have on several major European financial groups.

Barclays and Standard Chartered have been among the lenders cutting back the amount of borrowing they make available through the European inter-bank lending market, with Standard Chartered cutting its exposure by two-thirds within the last seven months.

Sir Mervyn warned that unless "decisive action" was taken more and more lenders would cut back the borrowing they made available to banks.

"If there is uncertainty about exposures and a lack of transparency, people simply do not know which other institutions could be at risk because of their direct and indirect exposures then there is always the risk that people may feel it is just not worth continuing to roll over funding to institutions if there is that degree of uncertainty," he said.

Next month, the London-based European Banking Authority will publish the results of the stress tests carried out by all the region's major banks, which is designed to give the market confidence in their financial strength.

"A great deal rests on this. It is very important that these stress tests to be published in the next month or so will indeed be credible," said Sir Mervyn.

The world's top central bankers and regulators, including Sir Mervyn and Lord Turner, are meeting in Switzerland this weekend to discuss the continued reform of the global banking system and dealing with the potential fall out of the eurozone crisis is likely to be at the top of their agenda.

Sir Mervyn and Lord Turner are strong advocates of imposing much higher capital requirements on the so-called GSIFIs, or global systemically important financial institutions, likely to include banks such as Barclays and HSBC.

These SIFIs are expected to face an additional capital 3pc Tier 1 capital requirement on top of the 7pc minimum that is being brought in as part of the Basel III bank capital rules.