Sir Mervyn King, governor of the Bank of England, warned on Friday that stopgap measures to extend new loans to countries such as Greece, Portugal and Ireland would not solve the eurozone debt crisis.
Presenting the Bank’s first analysis of financial stability in the UK banking system after the formation of the new financial policy committee, he said the eurozone debt crisis was a crisis of solvency that would not be resolved by extending new loans.
“Right through this crisis from the very beginning ... an awful lot of people wanted to believe that it was a crisis of liquidity,” Sir Mervyn said. “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 ... initially financial institutions and now sovereigns.”
Sir Mervyn’s views put him at odds with the ECB and eurozone governments which have extended hundreds of billions of euros in bail-outs to Greece, Ireland and Portugal in an attempt to solve the crisis.
But these countries have been faced with contracting economies as austerity measures introduced as conditions of the bail-outs have curtailed economic development and made it harder for the likes of Greece and Ireland to cope with their debts.
The European Central Bank, the IMF and governments in the eurozone are currently in talks about extending a €12bn aid payment to Greece to avoid inflicting a default on holders of Greek bonds that could reinflame the financial crisis.
“Providing liquidity can only be used to buy time,” Sir Mervyn said. “Simply the belief, ‘oh we can just lend a bit more’, will never be an answer to a problem which is essentially one about solvency.”
Sir Mervyn said that the eurozone debt crisis posed the biggest threat to the UK banking system but he noted that the risk was indirect because banks’ exposure to Greece was “remarkably small”.
The UK banking sector is less exposed to Greece than some of its continental peers, including France and Germany. Royal Bank of Scotland, still 83 per cent owned by the UK taxpayer, holds €1.1bn worth of Greek sovereign debt, while HSBC holds €800m, according to Barclays Capital. That compares with a direct sovereign exposure of €5bn at France’s BNP Paribas, and nearly €3bn at Germany’s Commerzbank.
The European Banking Authority is due to release country-by-country sovereign debt exposure for 90 EU big banks in mid-July as part of its stress tests.
The Bank governor said greater disclosure was needed by banks of their exposure to sovereign and banking debt.
He recommended that smaller banks, excluded from EU stress tests, should gather more data on sovereign and banking debt exposure.
In its analysis, the financial policy committee, the new body charged with overseeing the stability of the financial system, said that authorities needed to maintain a closer eye on complex and opaque financial instruments, such as exchange traded funds, that banks are using to raise funds.
Speaking at a European Council summit in Brussels to discuss a solution to the Greek debt crisis, David Cameron, UK prime minister, said: “Every bank needs to make absolutely clear what its exposure is [to European sovereign debt].
“As I have said, and secured in these Council conclusions, we need to make sure all our banks are being strengthened in terms of their capital reserves and what they can withstand.”
The report also said that banks should give more information on the extent of forbearance currently being given to the household and corporate sector.
The Bank has been asked to take on additional financial stability roles by the coalition government, including absorbing a large part of the FSA into its structure. The reforms vastly extend the Bank’s reach and responsibility in the UK economy and financial sector.
Additional reporting by Brooke Masters and Megan Murphy