The eurozone debt crisis poses the greatest risk to the stability of Britain's financial system and banks should increase capital reserves during strong earnings periods, Bank of England Governor Sir Mevyn King said on Friday at a press conference.
"The most serious and immediate risk to the UK financial system stems from the worsening sovereign debt crisis in several euro- area countries," the governor told reporters while releasing the central bank's Financial Stability Report and records of the first Financial Policy Committee (FPC) meeting on June 16.
The FPC, responsible for identifying risks and making recommendations to regulators on risk reduction, was created in the recent reform of Britain's financial regulatory functions.
King said British banks were at risk of financial contagion as they may be exposed to other lenders who may get into trouble if they were to suffer big losses on their loans to distressed eurozone countries, despite the fact that British banks haven't lent very much directly to Greece and other troubled economies.
The FPC recommended in its first meeting all British banks be permanently required to disclose more of their sovereign and banking sector exposures.
"There is always uncertainty about the scale of exposures," King stressed.
The FPC also recommended British banks take the opportunity of periods of strong earnings to build up capital levels in order to transit to the new Basel III capital requirements.
King urged the banks to pay out less of their profits to shareholders and employees as dividends or bonuses when earnings are strong, and use the money saved to increase capital reserves without having to cut back on lending.