The Bank of England said it stood ready to take any action required in response to Greece’s worsening debt crisis, which could trigger wider problems on financial markets.
Greece on Tuesday became the first advanced economy to default on an International Monetary Fund loan after the government in Athens broke off talks with its creditors and shut down banks.
The Bank of England’s warning coincided with a half-yearly review of risks by its Financial Policy Committee (FPC), in which the central bank said it was broadening out from Britain’s banks to look also at dangers linked to markets and the way they behave.
Governor Mark Carney said the BoE had prepared for the possibility of a Greek exit from the euro zone.
“Events in Greece have tipped the balance - the outlook has worsened,” said Mr Carney, speaking after publication of the review.
“The footprint of Greek banks in the United Kingdom is tiny compared with the size of our economy. In contrast, our economic and financial exposure to the euro area is considerable.”
British banks’ direct exposure to peripheral eurozone economies other than Greece amounted to the equivalent of 60 per cent of the core reserves that they hold against losses, the BoE said.
The FPC was alert to the possibility that the Greek crisis could prompt a broader reassessment of risk in financial markets, especially a reduced amount of liquidity that would make it harder for investors to offload shares and bonds when markets fall sharply.
As other major risks it listed Britain’s record current account deficit, the housing market, ballooning misconduct fines for banks and their vulnerability to hackers.
Since it was formally established in 2013, the FPC has mostly focussed on Britain’s banks, several of which the financial crisis forced taxpayers to rescue.
But the past year has seen significant volatility in normally safe financial assets such as British, German and American government bonds, with the pricing of a number of securities assuming they could always be readily sold, even at times of market stress.
Financial instability could result if a lack of liquidity then made it harder for banks, companies and households to borrow, the BoE said.
Central bankers and regulators will take a closer look at investment funds’ and companies’ exposure to market illiquidity.
Policymakers worry that when interest rates begin rising, the bond market will lack the capacity or liquidity to cope with a rush for the exits by investors.
Banks have scaled back on market-making, or being willing to take on buy and sell orders from investors at any time.
Market regulators have said asset managers already have the tools to cope with a surge in redemptions.
BoE Deputy Governor Andrew Bailey has said central banks could come under pressure to step in as market makers of last resort.
The FPC also said that the fines faced by banks for misconduct had risen to a level that undercut public trust in the sector and threatens stability.
High levels of debt had become slightly less of a problem in Britain’s housing market, but the BoE said lending curbs imposed last year remained necessary.