Euro crisis poses a clear and present danger to UK banks

Sir Mervyn King demanded an audit into the exposure of British banks to eurozone debt to ensure the UK is prepared for the worst.

His warnings came as European Union leaders urged Greeks to unite and accept higher taxes and public spending cuts as the price of a second bailout worth €12 billion, on top of the €110bn rescue package agreed last year.

EU heads of state met yesterday to discuss the crisis, with the UK negotiating a deal not to be involved in any bailout.

There are fears Greece will eventually default on its debt, and trigger a wider collapse, starting with the four other most vulnerable countries.

Portugal and Ireland's economies have already been rescued, while Spain could be the biggest economy to fail and Italy is struggling to bring its government spending under control.

Sir Mervyn resisted likening Greece to Lehmann Brothers, the US firm whose collapse triggered the world banking crisis in 2008. However, he suggested the problem in the eurozone had been misinterpreted, and that bailouts could only buy time, not rescue an economy.

He said: "Right through this crisis from the very beginning, an awful lot of people wanted to believe that it was a crisis of liquidity.

"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 (of] financial institutions and now sovereigns (countries]."

There has been disagreement over whether UK banks are exposed to 2.5bn of Greek debt, as claimed by the government, or the 8bn claimed by former Europe minister Denis MacShane. Sir Mervyn said: "The direct exposures of UK banks to Greece are really remarkably small."

However, he made clear he was worried about the overall exposure of UK banks to eurozone debt and the uncertainty over the total. "There is always uncertainty about the scale of exposures, (and] which counter-parties (financial institutions] out there are the ones which are heavily exposed," he said.

He said an audit had to be carried out to find out the actual level, and how well prepared the banks needed to be.

Prime Minister David Cameron backed the governor's comments. "Every bank needs to make absolutely clear what its exposure is, has to do that work," he told reporters after a European Council summit in Brussels.

"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.

"I am confident that that is taking place in the UK. We need to make sure it takes place right across Europe, and I think that's absolutely vital and what Mervyn King is saying is right."

Mr Cameron also vowed to remain "eternally vigilant in all matters European" after heading off a big British bill for a second EU bailout for Greece.

He said he had received the assurances he sought that the UK would not be required to make loan guarantees to the Greeks if a new rescue package is put together later this year.

"We were not involved in the first Greek bailout. We haven't been involved in talks about potential Greek bailouts. So I think it was absolutely right not to use the European Financial Stability Mechanism for future payments in terms of Greece."

But, aware he could be outvoted if other member states decided to involve Britain by using the mechanism, Mr Cameron added: "I wanted to seek assurances at this European Council that Britain won't be called on. I have received those assurances - but nevertheless I will continue to be vigilant on this issue."

Britain's only contribution to the multi-billion-pound bailout will come through its membership of the International Monetary Fund, which is expected to offer further support, committing about 1bn from the UK in loan guarantees.

Mr Cameron also claimed a victory in seeing off attempts to change European laws on migration that could have stopped the UK from sending asylum seekers back to other EU countries.

With up to a million people believed to have fled Libya during the current unrest, and tens of thousands attempting to cross from north Africa into Europe, the European Commission has floated proposals to suspend arrangements that require asylum seekers to be returned to the country through which they entered the EU.

But Mr Cameron said: "Britain and Germany together made sure that these proposals aren't even referred to in any way in the summit conclusions.

"I think that is important. We want controlled migration in Europe and controlled migration above all in Britain."

PIIGS in trouble

PORTUGAL

Received a €78 billion bailout last month after the credit rating agencies downgraded the country, forcing the government to seek help from the EU and IMF. In return for the loan, which includes €12bn for the country's banks, Portugal had to agree to araise taxes and cut spending.

ITALY

The least vulnerable of the countries as it has the lowest deficit, but it is still under threat because of its enormous public spending. If the Greeks default, it is one of the countries which would be least likely to absorb the shock, according to analysts.

IRELAND

Had to be bailed out by €113bn, including 7bn from the UK, largely in loans. Analysts say bailout seems to have worked, with the Irish government recently able to negotiate better payback terms. The economy had been destabilised by a property-bubble burst and a banking collapse.

GREECE

Seeking a new bailout of €12bn, which it is likely to get now ministers have agreed to more spending cuts and higher taxes. The socialist government is struggling to survive and, despite the new help, many think Greece will eventually default.

SPAIN

It is the fifth biggest economy in the EU and the largest under threat from being needed to be bailed out. The government there still denies it needs help but its credit rating by international agencies has been downgraded, pushing up the country's interest rates.