Bank warns of eurozone risks to UK as EU leaders meet

Economics Editor,Sean O'Grady
Friday 17 December 2010 01:00 GMT

Britain's banks are at risk from a renewed crisis in the eurozone, the Bank of England warns today.

In its latest Financial Stability Report, the Bank says that the UK is "only partially isolated given the interconnectivness of European financial systems and the importance of their stability to global markets". And, as the banks' £7bn bonus seasonapproaches, the Bank urges them again to rein in dividends and bonuses.

While the direct exposure of British institutions to the troubled peripheral economies such as Ireland, Greece, Portugal and Spain is limited, they have a much larger indirect exposure via their dealings with the French and German banking systems.

The European Central Bank is toalmost double the size of its cashreserves, with the strong possibility it will use those funds to buy more peripheral government bonds, increasingly unsaleable to private-sector investors. The ECB is to increase the reserves it holds to €10.8bn from €5.8bn.

However, the Bank has also produced data to show that the British banks are better placed than most of their international peers to sustain losses, though they still face significant funding challenges as official support is gradually withdrawn. The UK banks have also benefited from the £200bn the Bank has directly injected into the system via its policy of quantitative easing, of which some £150bn is still in the hands of the banks. New machinery, which allows distressed banks to borrow against a wider range of collateral, should also help them survive anyinterruption to wholesale funding.

The Bank's report comes as David Cameron, the Prime Minister, met other EU leaders at a summit to discuss ways to contain the succession of crises that has threatened the euro. The euro rose modestly in trading yesterday, though Spanish bond markets continued to suffer from fears about the country.

Meanwhile, Mervyn King, Governor of the Bank, was appointed vice-chair of the new European Systemic Risk Board, set up to act as an "early warning system" for developing bubbles and other threats to financial stability.

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