Eurozone debt crisis poses biggest threat to UK stability

The eurozone debt crisis poses the “most material and immediate threat” to the UK’s financial stability, according to a report by Sir Mervyn King’s Financial Policy Committee.

“Sovereign and banking strains are the most material and immediate threat,” the committee, chaired by the Bank of England governor, said in its inaugural report.

The committee called for banks to improve their disclosure of sovereign and bank sector exposure and also warned that authorities needed to keep a closer eye on the explosion of “opaque” products such as exchange traded funds (ETFs), which banks increasingly use to raise funds.

It follows an overnight victory for David Cameron in preventing British taxpayers’ money being used to bail out Greece.

At a European Union summit in Brussels, the Prime Minister won a fight with Angela Merkel, the German Chancellor, to keep Britain out of any new rescue package.

Germany had wanted to use money from the European Financial Stability Mechanism to bail out Greece. Britain is a contributor and has no veto on how its €11.85billion (£10.5billion) funds are used.

But Herman Van Rompuy, the EU president, said that the EFSM would “not be part of the package”.

Speaking at a news conference hours later, Sir Mervyn King said uncertaintainty over exposure to countries such as Greece could lead to a “crisis of confidence”, which posed a bigger risk than direct exposure.

“There is always uncertainty about the scale of exposures, which counter-parties out there are the ones which are heavily exposed,” he said.

“That uncertainty can lead at various points for funders of banks…to draw back and there can be a crisis of confidence in sentiment in which people say ‘I simply don’t understand the complexity of the interconnectedness of these exposures and I just won’t take the risk of lending’. And that is the bigger risk, I think.”

Mr King also said that the ongoing crisis in Greece was not a matter of liquidity, but solvency, and a build-up of large amounts of debt:

“Right through this crisis…an awful lot of people wanted to believe that this was a crisis of liquidity. It wasn’t, it isn’t. And until we accept that we will never find an answer to it. It was a crisis based on solvency or to be more precise, the build up of very large amounts of debt where concerns crept in on the ability of the borrowers to repay that debt,” he said.

The report came as EU leaders scramble to avert a Greek debt default that would send shockwaves through international markets.

Greece secured the backing of European leaders late last night for its five-year austerity plan, which Greek ministers will vote on next Tuesday.

Britain’s benchmark FTSE 100 index opened up more than 1pc as Greece secured the backing of European leaders late last night for its five-year austerity plan, which Greek ministers will vote on next Tuesday.

Markets also rallied in Asia, with the Hang Seng index in Hong Kong climbing 1.8pc as Chinese Premier Wen Jiabao said he was confident that price rises would be kept firmly under control this year.

Speaking in Prague before flying to Brussels, Mr Cameron said it would be “quite wrong” to ask Britain to contribute to rescuing Greece, while German officials said the stability mechanism should be used.

Mr Cameron will also use the summit to argue that the EU should exempt small firms from new red tape. “This is the right outcome for the British taxpayer,” said a Downing Street source.

Earlier this week, aware of the potential domestic outcry if Britain had to stump up billions for Greece, Chancellor George Osborne told fellow EU finance ministers at talks in Luxembourg that the UK did not expect to be called upon.

Flying to the summit for talks over dinner, Mr Cameron reinforced the message, saying that the UK wanted to see a healthy single currency – but one which dealt with its problems within the club of 17 eurozone member states.

When the eurozone suffered, the UK suffered, Mr Cameron acknowledged, and the UK would fulfil its financial obligations as a contributor to any International Monetary Fund support for the troubled Greek economy – to the tune of about one billion euros in loan guarantees.