Bank of England Governor Mervyn King yesterday urged banks to brace themselves for a eurozone collapse.
Introducing the latest financial stability report, King said: ‘Faced with a crisis of the euro-area system, we are seeing at first hand the costs of financial instability.’
He added: ‘Many European governments are seeing the price of their bonds fall, undermining banks’ balance sheets. In response, banks, especially in the euro area, are selling assets and deleveraging.
‘An erosion of confidence, lower asset prices and tighter credit conditions are further damaging the prospects for economic activity and will affect the ability of companies, households and governments to repay their debts.
‘That, in turn, will weaken banks’ balance sheets further. This spiral is characteristic of a systemic crisis.’
He stressed: ‘Tackling the symptoms of the crisis without resolving the underlying causes, by measures such as providing liquidity to banks or sovereigns, offers only short-term relief.
‘Ultimately, governments will have to confront the underlying causes.’
He further warned: ‘The problems in the euro area are part of the wider imbalances in the world economy.
‘The end result of such imbalances is a refusal by the private sector to continue financing deficits, as the ability of borrowers to repay is called into question.
‘Resolving these wider problems is beyond the control of any UK authority.’
Appearing in his role as chair of the interim Financial Policy Committee (FPC), King said: ‘In the UK, we must try to bolster the resilience of our financial system to better withstand the storms that may come in our direction.’
King’s warning follows that of prime minister Cameron that the UK is in the grip of a second credit crunch.
In its final meeting of the year, the interim FPC labelled the euro-area crisis as the ‘most significant and immediate threat to UK financial stability’.
The FPC said that UK banks’ exposure to government debts of Greece, Portugal, Italy, Spain and Ireland totalled £14.8bn. Total exposure to the ‘vulnerable five’, including private sector debt, is £191.8bn.
• Meanwhile the head of the Financial Services Authority (FSA), Hector Sants, urged the UK’s biggest banks to prepare for a break-up of the eurozone.
Senior executives from Barclays, HSBC, Lloyds Banking Group, RBS, Santander UK and Standard Chartered were given the warning at a private meeting with Sants.
Sants said the banks should run a wide range of stress tests as part of their contingency planning.
FSA head of banks and building societies, Andrew Bailey, commented: ‘Good risk management means planning for unlikely but severe scenarios, and this means that we must not ignore the prospect of the disorderly departure of some countries from the eurozone.’
Standard Chartered chief economist Dr Gerard Lyons yesterday warned that he does not foresee the euro being able to survive the crisis unless Greece ‘makes an orderly exit’.
