Financial system in ‘crisis’ warns Mervyn King as he plans for break-up of eurozone and tells banks to slash staff bonuses

Sir Mervyn King warns eurozone crisis 'beyond the control' of any UK authority



Bank of England preparing for the worst case scenario

Downing Street says Britain is in the grip of a second credit crunch

But Governor says Britain's banks are among the strongest in the world



Crisis: Sir Mervyn King, pictured speaking, warned resolving the eurozone crisis was 'beyond the control' of any UK authority

The financial system is in 'crisis' and banks should get their houses in order to protect from a second credit crunch, the Bank of England said today.

Governor Sir Mervyn King said meltdown in the eurozone was 'the most significant and immediate threat to UK financial stability'.

He warned that banks need to raise more funds to shield themselves from 'the current exceptionally threatening environment'.

Banks should keep lending to households and businesses but cut bonuses for staff and dividend payments to shareholders, he said.

Deputy governor Paul Tucker described the situation as 'exceptionally perilous' and warned that 'anything could happen'.

The language - rare for usually reserved central bankers and the strongest since the crisis erupted four years ago - underlined the severity of the situation.

Appearing in his role as chair of the interim Financial Policy Committee (FPC), the Governor said: 'In the UK, we most try to bolster the resilience of our financial system to better withstand the storms that may come in our direction.'

The FPC told commercial banks they must build up their reserve funds - known as capital buffers - as increased insurance against possibly catastrophic developments in the eurozone.

They must maintain lending to businesses, but should slash dividends and bonuses - and possibly even issue new shares - to raise the cash they need, the committee said.

In the recent 'stress test' of EU banks, UK lenders were not asked to raise any extra capital but the Bank remains cautious.

'There is no simple answer to how much capital banks need to retain confidence,' Mr King added.

The Bank of England has joined in the dramatic rescue bid to help prevent a repeat of 2008, when major banks simply stopped lending to each other The ring-fencing of retail arms of UK banks with dedicated capital cushions, a core recommendation of the recent Vickers Commission which set a 2019 deadline, should also be implemented as soon as possible, he said. And in a sign that the FPC does not trust how banks report how indebted they are, it recommends that they be ordered to publish leverage ratios from the start of 2013, two years earlier than international Basel III rules require. The interim FPC issued its first recommendations in June. Currently it only has an advisory role, but new laws are expected to make it Britain's top financial regulation body from the start of 2013. Its role is to plug a pre-crisis gap by taking a broader view of risks to financial stability and recommending or ordering specific actions. The FPC's warning comes after Downing Street said that Britain was in the grip of a second credit crunch, and six central banks, including the Bank of England, acted to encourage lending between banks and stave off economic stagnation.

Risks: Graph shows the exposure of banks over time

Sir King admitted today that the Bank was preparing for the worst-case scenario.

He said: ‘As you would expect, the Government, along with the Financial Services Authority and the Bank of England are making a range of contingency plans. I’m not going to go into detail as to what they are but we are certainly making contingency plans.

‘There are many different ways in which the future could play out. I’m not going to speculate about what could happen in the future.’

He also said that banks should cap bonuses or dividends if their balance sheets do not appear to be robust enough to withstand major financial shocks, such as a collapse of the euro or a UK credit downgrade.

However, he said that Britain's banks were among the strongest in the world - and better capitalised than their European counterparts.

In its final meeting of the year, the interim Financial Policy Committee (FPC) labelled the euro area crisis as the 'most significant and immediate threat to UK financial stability'.



In its financial stability report, the FPC said UK banks' exposure to government debts of the so-called vulnerable five - Greece, Portugal, Italy, Spain and Ireland - totalled £14.8 billion.



Total exposure to the vulnerable five, including private sector debt, is £191.8 billion.



However, Sir Mervyn said UK banks were in a better position than their continental peers to withstand future financial shocks.



Credit conditions in the UK could tighten if banks are forced to take higher losses on exposures to the euro area - where the FPC warned there are already signs of a credit contraction.



Sir Mervyn added: 'The crisis in the euro area is one of solvency and not liquidity. And the interconnectedness of major banks means that banking systems, and hence economies, around the world are all affected.'



Central banks – including the Bank of England and China’s equivalent – yesterday launched a dramatic rescue bid worth hundreds of billions of dollars.

It was agreed to head off a repeat of the 2008 crash when banks simply stopped lending to each other, bringing the world economy to a halt.

The operation, led by the U.S. Federal Reserve, came amid fears that at least one major European bank may be teetering on the brink of collapse and that the eurozone countries could not be trusted to act swiftly enough to solve their problems.

Investors are increasingly worried that European banks are exposed to huge losses on loans they have made in Greece, Italy and other indebted countries.



Europe's leaders will hold yet another summit on December 9, where it is hoped they will deliver the final word on a response to the eurozone crisis.

Last night in Brussels, one of the EU’s most senior officials warned there were now just ten days left to save the euro from collapse.

Stock markets around the world rallied yesterday in response to the ‘pre-emptive strike’, with the FTSE 100 index closing up more than three per cent.

Today it failed to make significant gains after the Governor's grim warning.

Bank stocks fell after Sir Mervyn urged lenders to brace themselves for a potential eurozone collapse amid fears that the UK is caught in a second credit crunch.



Lloyds shares were down 0.6p at 24.2p, Royal Bank of Scotland had fallen 0.4p to 20.6p, and Barclays was down 2.7p at 177.6p.

