European sovereign debt and banking problems could become a threat to UK banks and the economy, according to the Bank of England.
In its half-yearly financial stability report, the central Bank said the main risks affecting UK banks involved lending to euro-area households and companies if the debt crisis worsens.
It says: “The main credit risks to UK banks stem from the possibility of losses on lending to euro-area households and companies, should sovereign and banking concerns spillover to weaker-than-expected growth in the euro area. Heightened sovereign risk in Europe could also expose UK banks to funding risks and the UK economy to the withdrawal of lending by foreign banks.”
The bank suggested it is important to develop a “comprehensive, rather than country-by-country, solution”, due to the nature of the debt crisis.
The report adds: “Recent events also underline the need for the next EU-wide stress-test exercise to provide greater transparency about banks’ resilience to these risks.”
The BoE also says low government bond yields remains one of the main sources of risk to the financial system.
It warned yields are susceptible to a “sudden reversal”, which would could “lead to contagion across asset markets”, as happened with the 1994 bond market sell-off.
The report says: “That adjustment in capital markets had adverse consequences for both banks’ funding and banking books. The contagion could be even more marked this time, given the closer integration of global capital markets.”