By Simon Miller

The Financial Policy Committee (FPC) has warned that the continuing sovereign and banking debt risks in Europe remain the most significant threat to the UK.

The FPC said that given the current "exceptionally threatening environment", it recommended that if earnings were insufficient to build capital levels further "banks should limit distributions and give serious consideraton to raising external capital in the coming months".

Despite this, the FPC pointed out that it didn't think the current levels of capital in individual banks were insufficient.

Speaking at the publication of the Financial Stability report, Bank of England governor Mervyn King commented: "UK banks are better capitalised than many of their Continental peers."

He continued: "It reflects a judgement that it is sensible and desirable to raise capital buffers further in order to improve resilience in light of the continuing threats to UK financial stability, while at the same time enhancing the capacity of banks to provide credit to the wider economy."

In addition the FPC repeated its advice to the Financial Services Authority (FSA) that it should encourage banks to improve the resilience of their balance sheets without exacerbaing market fragility or reducing lending to the real economy".

The FPC also recommended that despite banks not having to report a leverage ratio until 2015, it was urging the FSA to encourage banks to do so as part of their regular reporting not later than the beginning of 2013.

"The crisis in the euro area is one of solvency and not liquidity. And the interconnectedness of major banks means that banking systems, and hence economies, around the world are all affected," said King.

He concluded: "Only the governments directly involved can find a way out of the crisis. But here in the UK, we must try to bolster the resilience of our financial system, better to withstand the storms that may come in our direction."

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