The Governor of the Bank of England warns banks to brace themselves for a potential eurozone collapse by increasing reserves, adding that the BoE has “contingency plans” for a euro meltdown.
Sir Mervyn spoke as the BoE’s Financial Policy Committee published a report in which it recommended that British banks “improve the resilience of their balance sheets without exacerbating market fragility or reducing lending.”
He said financial systems around the world are vulnerable to the eurozone debt crisis and its underlying causes – but warned a resolution was “beyond the control” of any UK authority.
But he told a press conference that the BoE, together with Britain’s government and financial watchdog, the Financial Services Authority (FSA), “are making contingency plans,” although he refused to elaborate.
His comments came after Downing Street warned last night that Britain was in the grip of a second credit crunch, and six central banks acted to encourage lending between banks and stave off economic stagnation.
Amid fears of a eurozone collapse, central banks of the United States, the eurozone, Britain, Japan, Canada and Switzerland said on Wednesday that they would cut the cost of providing dollars to banks.
King said Thursday that the joint move “is a step forward and will help, but let me stress that this cannot be a solution to the underlying problems.
“All this can do is to help with some temporary relief to liquidity problems, but liquidity problems often reflect underlying solvency problems and in this case they do and those problems have to be tackled directly by the governments involved.
“Central banks… cannot resolve solvency problems, they can merely provide liquidity,” he told a press conference in central London.
The report added that the risks of a eurozone collapse have greatly increased since the summer.
“Sovereign and banking risks emanating from the euro area remain the most significant and immediate threat to UK financial stability. These risks have intensified materially since June 2011,” it said.
“Against a backdrop of slowing global growth prospects, market concerns about the sustainability of government debt positions of smaller economies have broadened to larger euro-area economies”
“Capital market functioning has deteriorated and risky asset prices have fallen sharply. Risk capital has been reallocated, as investors have sought to reduce exposures to vulnerable euro-area countries and to riskier assets more broadly.”