Biggest risks to UK economy

Unstable financial markets Bad debt in emerging markets Credit card lending Telecom debts US slowdown

Although the UK financial system remains strong, the Bank warned that soaring commercial property prices and credit card lending was putting British banks at risk.

In its twice-yearly Financial Stability Review, the Bank forecasts growing instability in global financial markets.

And it warns that US shares are probably still overvalued and that risks from emerging markets have increased.

'Stress test'

By previous standards, levels of personal debt compared to income in the UK were high, the Bank said, which might have an adverse impact on the economy if house prices started to fall.

The number of unsecured loans had also increased dramatically in recent years, which might pose a problem if the economy worsens.

So far it (the UK economy) has proved resilient

David Clementi, Bank of England deputy governor

However, there were few signs of a generalised credit crunch in international banking or capital markets, the Bank said, despite the economic slowdown extending beyond the US and a sharp fall in demand in the information and communications technology sectors.

The Bank's deputy governor David Clementi said the US slowdown and the global correction in telecom and technology shares had been like a "natural stress test" for the international financial system as a whole.

"So far it has proved resilient. The environment may, however, now become more difficult than appeared likely six months ago, especially if the slowdown in world activity were to turn out to be longer or deeper than currently expected," Mr Clementi said.

Telecom worries

The Bank said it was worried about levels of debt in the telecom sector, where equipment suppliers had exposed themselves to too much risk when providing finance to start-up operators.

The bank said it could not rule out a significant 'credit event' in relation to such companies.

In other words, there was a danger that some companies would default on a bond or loan, restructure their debt or even go out of business.

But it added: "The problems are not new and lenders have had time to disperse the risks, although it is difficult to judge the extent to which they have done so."

US uncertainty

The Bank said substantial capital accumulated from high profits in recent years should help internationally active banks face the global slowdown, a rise in credit risks and continuing market risks.

It described financial market infrastructure as "robust" and said market liquidity had been "unimpaired" by financial developments of the past six months.

Going forward, the uncertain direction of the US economy was a major potential source of risk, with implications for asset markets, exchange rate risks, personal and corporate debt and the property market.

People in the US were saving less and taking longer to pay off their credit card bills, the bank said, and this was a sure sign that they were starting to feel the economic pinch.

In such circumstances, it warned, there was a greater risk of defaults on unsecured personal loans - and some problems had already begun to emerge.

Efforts at structural reform to boost Japan's lacklustre economy could also have wider financial stability implications if problems became more acute, affecting emerging market economies in the region through trading and investment links.

Emerging markets

The UK banking system appeared well placed to accommodate increasing credit risk, although it said the risk on some emerging market economy exposures like Turkey, Argentina, Brazil and Indonesia had probably increased since December.

Some export-dependent Asian economies would be more vulnerable to a global slowdown but a risk of spillover outside Turkey did not appear serious.

Any future problems from Argentina could spill over to Brazil but the risk of widespread effects were likely to be small except for financial systems with concentrated emerging market exposures like Spain to Latin America.