[LONDON] The Bank of England said it stands ready to "take any actions required" after Greece's rapid economic slide in just the past few days.
Greece became the first advanced economy to default on a loan to the International Monetary Fund on Tuesday after the government broke off talks with its creditors and shut down banks.
The Bank of England's warning in a half-yearly review of risks by its Financial Policy Committee echoes one from British finance minister George Osborne earlier on Wednesday. "The situation remains fluid. The FPC will continue to monitor developments, and remains alert to the possibility that a deepening of the Greek crisis could prompt a broader reassessment of risk in financial markets," the BoE said.
The BoE said British banks' direct exposure to Greece was"very small", but that their exposure to other peripheral euro zone economies amounted to the equivalent of 60 per cent of the core reserves that they hold against losses.
The BoE listed five other major risks: a lack of market liquidity, Britain's record current account deficit, the housing market, ballooning misconduct fines for banks and their vulnerability to malicious hackers.
The Financial Policy Committee has mostly focused on Britain's banks since it was set up after the financial crisis forced taxpayers to rescue several lenders.
But on Wednesday the risk watchdog said it was broadening its focus to look at dangers posed by financial markets, especially the reduced amount of liquidity, which makes it harder for investors to offload shares and bonds when markets fall sharply.
The past year has seen significant volatility in normally-safe assets such as British, German and American government bonds, the last of which was dubbed the 'taper tantrum'.
The BoE said that the pricing of a number of securities seemed to assume they could always be readily sold, even at times of market stress. "Compensation for bearing credit and liquidity risk in some markets has declined by more than may be warranted by the future economic and financial environment," the BoE said.
Financial instability could result if a lack of liquidity made it harder for banks, companies and households to borrow, the BoE said.
Central bankers and regulators will take a closer look at investment funds' and companies' exposure to market illiquidity.
Policymakers worry that when interest rates begin rising, the bond market will lack the capacity or liquidity to cope with a rush for the exits by investors.
Banks have scaled back on market-making, or being willing to take on buy and sell orders from investors at any time, blaming more costly capital requirements on holding inventories of bonds introduced after the financial crisis.
Market regulators have said that asset managers already have the tools to cope with a surge in redemptions, such as imposing penalty charges or even suspending withdrawals entirely.
BoE Deputy Governor Andrew Bailey has said central banks could step in as market makers of last resort.
The FPC also said on Wednesday that the fines faced by banks for misconduct had risen to a level which undercuts public trust in the sector and threatens stability. This year's 'stress test'of top British lenders will check whether banks have been open enough about the scale of future fines they may face for malpractice.
Banks will also face regular tests of their defences against and ability to recover from cyber-attacks.
High levels of debt had become slightly less of a problem in Britain's housing market, but the BoE said lending curbs imposed last year remained necessary, and said it still wanted the government to give it powers to regulate lending to small landlords.
BoE Governor Mark Carney is due to present the half-yearly report at a news conference starting at 0930 GMT, when he is likely to face questions about Britain's vulnerability to Greece's deepening debt crisis.