Bank says economic climate 'extraordinarily serious'

Sir Mervyn King: "We must try to bolster the resilience of our financial system"

Banks should brace themselves to withstand the "extraordinarily serious and threatening" economic situation, the Bank of England governor has said.

The Bank's Financial Policy Committee (FPC) said the eurozone crisis was the biggest threat to the UK's banking system.

It said banks should build up their financial buffers to withstand that.

Bank governor Sir Mervyn King said the Bank itself was making "contingency plans" in case of a eurozone break-up.

However, he would not go into any details as to what these were.

Sir Mervyn said it did not make sense to say that there was "a single well-defined event against which we have to make contingencies".

He said: "There are many ways in which the future could play out. Maybe it [the eurozone] won't break up, maybe it will continue in various forms, but maybe there will still be questions of default."

On Wednesday, six central banks, including the Bank of England, took action to encourage lending between banks in order to keep the global economy moving.

But Sir Mervyn said that, "ultimately, governments will have to confront the underlying causes".

Analysis

If anyone was in any doubt about the severity of the eurozone crisis and what it might mean for the UK, they shouldn't be any more.

The governor of the Bank of England delivered his starkest warning yet. It's quite something for a central banker to describe the financial climate as "extraordinarily serious and threatening".

Sir Mervyn King made no attempt to play down speculation about the possible break-up of the eurozone. He thinks banks can weather storms ahead if they set aside more capital.

But he acknowledged that the problems were widespread and beyond the control of any UK authority.

To sum up the financial regulators' message - fasten your seatbelts for what could be a very bumpy ride.

"Resolving these wider problems is beyond the control of any UK authority," he added.

Earlier, president of the European Central Bank (ECB), Mario Draghi, told the European Parliament that "downside risks" to the eurozone economic outlook had increased.

Dividends and bonuses

Sir Mervyn said that the UK's banks were among the strongest in the world, with tier 1 capital ratios - an internationally respected measure of a bank's strength - at well above 12%.

That is higher than they were before the credit crisis began in 2008.

Sir Mervyn said one way for UK banks to gain further strength would be to raise money by issuing new shares.

The FPC also said that banks should keep lending, but should cut dividends and bonuses in order to help build up their financial reserves.

Some bankers argue that tighter capital requirement rules mean lower lending, as banks are forced to hang on to assets as a contingency, rather than pass it on to borrowers.

The chief executive of Royal Bank of Scotland, the bank now majority-owned by the UK government, said recently that strict regulation meant investors saw UK banks as a "dumb" place to invest, and that it limited banks' ability to lend.

The FPC is chaired by Sir Mervyn, and at present only has an advisory role.

Once the legal framework is in place, it is expected to become the country's top financial regulator from the start of 2013.

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