The Bank of England has warned of the prospect of an unprecedented financial crunch next March with trillions of pounds of derivatives effectively ceasing to function unless Europe rapidly comes up with a fix.

The Bank said that UK banks were strong enough to withstand even a hard Brexit, with their levels of capital hitting new post-crisis highs.

However, it said that while progress had been made on this side of the Channel, European authorities had failed to pledge the implementation period that would prevent financial chaos next March.

In its Financial Stability Report, the Bank said that £29trn of derivative contracts, the instruments which sit beneath the financial system, could become unserviceable when the UK formally leaves the EU next March.

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Because those derivatives rely on cross-border co-operation and because the European Commission has failed to follow the UK's lead and commit to an implementation period for finance, they would stop operating as normal.

There has never been a similar episode in recent financial history.

The Bank's warning will be seen as the latest salvo in an increasingly tense war of words between UK and EU financial authorities.

How much time does the @bankofengland spend dealing with Brexit? Mark Carney: "The answer is a lot" — Ed Conway (@EdConwaySky) June 27, 2018

The European Banking Authority said this week that banks were not yet prepared for Brexit, while UK authorities, including the Bank, have said they are - provided the government gives them an implementation period in which to rearrange their contracts, derivatives and legal arrangements.

The Bank said that in the UK the risks posed by Brexit had decreased and that banks are now strong enough to withstand a deep financial and economic crisis, including, potentially, this derivative crunch.

It said the amount of capital in their balance sheets - a key measure of solvency and robustness, has risen from 5% at the start of the financial crisis to 17% of risk-weighted assets.

And while it said UK household and corporate debt levels remained low, there were other risks worth noting.

It pointed to levels of leveraged lending (borrowing by indebted organisations) which have now exceeded the pre-crisis highs. It said international risks - especially in emerging markets - had risen, leaving UK investors and banks potentially exposed.

I find this chart a bit scary. Total amount of leveraged loan issuance by UK firms (eg lending to highly indebted companies etc) now comfortably exceeds the pre-crisis peaks. Chart from @bankofengland: pic.twitter.com/OL3kDBE17u — Ed Conway (@EdConwaySky) June 27, 2018

It warned of rising debt costs in the US and said that banks needed to be prepared for the prospect of a cyber attack.

For the first time, the Bank will conduct a cyber stress test, in which it simulates a system-wide online attack on banking systems.

It underlines how concerned authorities now are about the risk of cyber attacks on key functions of the economy - whether by private or state actors.

Responding to the Bank's Brexit warning Miles Celic, chief executive of the lobby group TheCityUK, said: "The biggest threat to financial stability right now is continuity of contracts post-Brexit.

"The biggest barrier to addressing this issue is the EU regulators' failure to accept and get to grips with the risk.

"This must not be drawn into the politics of Brexit - it is a technical challenge which needs a technical solution.

"The industry is doing everything it can to address this problem and propose a workable solution, but it cannot do so alone.

"EU regulators need to explain what is preventing them from taking the reasonable steps necessary to defuse this risk to the European financial system.

"The time has come for European regulators to focus less on the negotiating ambitions of Brussels and more on the needs of customers."