UK banks are being told to prepare for a “systemic crisis” which could include the break-up of the eurozone.
The warning came this week from Bank of England governor Mervyn King, who says UK banks need to start stockpiling money.
British banks are owed $11 billion by Greece and $25 billion by Portugal – but both are dwarfed by the $72 billion debt outstanding from Italy.
King urged UK banks to limit bonuses, stop paying dividends and ask their shareholders for more capital.
He also admitted that contingency plans were being drawn up to prepare for a possible break-up of the eurozone.
Meanwhile European Central Bank head Mario Draghi called on eurozone nations to agree new rules to restore credibility to the eurozone.
Speaking in the run-up to another key European Union summit next week, he warned time was running out to stop the crisis spreading like a virus around the world.
“It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union.”
His comments came a day after the world’s major central banks took emergency joint action to provide cheaper US dollar funding for starved European banks.
As UK banks prepare for the worst, Australia’s big four banks – Westpac, the Commonwealth Bank, ANZ and NAB, were hit this week with a ratings downgrade from AA to AA-.
The revisions by Standard and Poor’s (S&P) come as ratings agencies reassess their definition of risk.
Earlier this week, S&P cut the ratings of 15 banks in Europe and the US due to the revised criteria.
These downgrades were expected, but provide more evidence that the global banking system is operating in an increasingly uncertain environment, and that Australia would not be immune to a further deepening of the European economic crisis.
The big four Australian banks have 40 per cent wholesale funding exposure to global finance markets.
Speculation remains that China may come to Europe’s rescue by investing its substantial foreign exchange reserves in the eurozone’s bail-out fund. China already owns 60 per cent of global reserves.
But bailing out developed countries may be a hard sell for China’s leaders, with soaring housing and food costs in China affecting millions of poorer households and many small exporters struggling to pay their bills.
This week, China’s central bank relaxed regulations on cash reserves to encourage new lending, while six of the world’s central banks, including the Bank of England and the US central bank, moved to sure up debt-laden nations by freeing capital to provide much-needed US dollars – the measures being taken to offset the difficulties increasingly faced by foreign banks to borrow in $US.