Bank of England says primed for action over Greek crisis

By David Milliken and Huw Jones

LONDON (Reuters) - The Bank of England said on Wednesday it stood ready to take any action required in response to Greece's worsening debt crisis, and warned that lack of liquidity left financial markets vulnerable to a sell-off.

Greece's troubles were the most rapidly looming threat to financial stability in Britain, the BoE said, but other dangers came from a record current account deficit, highly indebted housing market and threats to banks from computer hackers and misconduct by their own staff.

The greater focus on financial markets highlights the BoE's growing interest in areas beyond formerly troubled banks, potentially setting up a clash with other regulators and the asset-management industry.

The central bank's warnings came in a half-yearly report that had to be revised after Greece imposed capital controls and shut its banks at the weekend, before a referendum on unpopular economic reforms and spending cuts.

BoE Governor Mark Carney said the BoE had prepared for the possibility of a Greek exit from the euro zone, echoing a warning from Chancellor George Osborne earlier in the day.

"Events in Greece have tipped the balance - the outlook has worsened," said Carney when he presented the report.

So far, little of Greece's troubles had spread to the rest of the European economy, but the potential impact of a Greek exit from the euro could be large.

"The footprint of Greek banks in the United Kingdom is tiny compared with the size of our economy. In contrast, our economic and financial exposure to the euro area is considerable."

Later on Wednesday, after Prime Minister Alexis Tsipras told international creditors that Athens could accept their bailout offer if some conditions were changed, Carney told Sky News that the situation was very fluid. It was in the interests of Greece and its creditors to reach a deal as soon as possible, he said.

British banks' direct exposure to peripheral euro zone economies other than Greece amounts to 60 percent of the core reserves that they hold against losses.

BRITTLE MARKETS

The FPC said it was alert to how the Greek crisis might prompt a broader reassessment of risk in financial markets, especially as a shortage of liquidity could make it harder for investors to sell bonds when markets fall.

"The risks arising from Greece and the global economy will test market liquidity and could potentially trigger broader adjustments," Carney said.

Partly because of tougher regulation since the financial crisis, banks have scaled back on market-making, or being willing to take buy and sell orders from investors at any time.

Policymakers worry that when interest rates rise, the bond market will have trouble coping with a rush for the exits by investors, ultimately making borrowing harder for ordinary businesses and households.

The past year has seen significant volatility in normally safe financial assets such as British, German and American government bonds, and the BoE said the pricing of a number of securities assumed they could always be readily sold.

Market regulators say asset managers already have tools to cope with a surge in redemptions. But BoE Deputy Governor Andrew Bailey has said central banks could face pressure to be market makers of last resort.

The FPC also said on Wednesday that the fines faced by banks for misconduct had risen enough to undercut public trust in the sector and threatens stability, and that it would soon start to test banks' resilience against cyber-attacks.

High debt had become less of a problem in Britain's housing market, but the BoE said lending curbs imposed last year remained necessary.

(Additional reporting by Andy Bruce; editing by Larry King)