Bank of England calls for audit of eurozone crisis risk

Sir Mervyn King: "Greece debt problems pose the most serious and immediate risk to UK banks"

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The Bank of England's new financial policy committee (FPC) has called for an audit of UK banks' exposure to the eurozone debt crisis.

The Bank's governor Sir Mervyn King said the debt problems of Greece and other countries posed "the most serious and immediate risk" to UK banks.

The FPC also called for banks to divert their profits towards building up their reserves against future losses.

Prime Minister David Cameron welcomed the committee's suggestions.

"Every bank needs to make absolutely clear what its exposure is," he said following a European Council summit in Brussels.

"We need to make sure all our banks are being strengthened in terms of their capital reserves and what they can withstand."

UK lenders need to build up their capital buffers as part of the Basel III international agreement, which was designed to ensure that all banks worldwide are better able to withstand another financial crisis.

Sir Mervyn said that by paying out less of their profits to shareholders and employees, the banks could rebuild their capital without having to cut back on lending.

In the conclusions of its first meeting, the committee asked the soon-to-be-replaced Financial Services Authority (FSA) to ensure that the banks it supervises comply with the recommendation.

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The Bank of England points out that there is an 80% probability that the Greek government won't be able to repay all its debt”

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Tangled web

Regarding the eurozone, the Bank governor said that while UK banks may not have lent very much directly to Greece and other troubled economies, they were still at risk of financial contagion.

"The direct exposures of UK banks to Greece are really remarkably small," he said in response to a question at the press conference.

But he said that British banks may be exposed to other lenders who may get into trouble if they were to suffer big losses on their loans to distressed eurozone countries.

The FPC said that all banks, big and small, should be permanently required to report more thoroughly their exposures to different countries.

"There is always uncertainty about the scale of exposures, which counter-parties out there are the ones which are heavily exposed," he explained.

He said this can lead to a crisis of confidence in the banks, because lenders cannot untangle the web of risk exposures involved.

'Gift'

Sir Mervyn also queried whether the emergency loans being arranged for Greece would do much to save it from default.

"Simply the belief that we just lend a bit more will never be [an] answer [to a question] which is essentially one of solvency," he said.

He said that a country such as Greece, that had more debts than it was able to repay, had two options.

"One is to receive gifts or transfers from other countries," he said - something that goes well beyond the loans being discussed with European counterparts.

The Bank governor did not specify whether a default by Greece on its debts might also constitute such a "gift", provided by Greece's existing lenders.

The second option was improving competitiveness to enables the "current account deficit to be turned into a surplus".

Many economists have said that the most obvious way for Greece to do this is by leaving the euro and allowing its currency to devalue.

Opaque

Among the committee's other recommendations was that the FSA carry out a more extensive review of whether the banks have set aside enough money to cover possible losses on their lending and how much debt relief they are granting customers.

The FPC also raised a warning flag over "exchange-traded funds" or ETFs.

Sir Mervyn said that many of these funds - which are traded on the stock exchange and offer investors the return on an index or portfolio of investments - were opaque.

Speaking at the same press conference, Hector Sants, who runs the FSA, questioned whether "synthetic ETFs" - which use financial derivatives to make their investments - were appropriate for ordinary individual investors.

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