The debt crisis in the Eurozone periphery poses significant threat to the financial stability in the United Kingdom, the Bank of England said Friday.

The record of the June 16 meeting of the new Financial Policy Committee (FPC) said, "The Committee judged that sovereign and banking sector strains in some vulnerable euro-area economies were the most material and immediate threat to UK financial stability."

"UK banks' direct exposures to the most vulnerable euro-area sovereigns were limited, but they had larger claims on the private sectors of some of those economies."

Credit risks could also emerge from links between banking systems, the central bank said. The report also warned against the risk that a sharp deterioration in vulnerable European economies may result in adverse implications for credit conditions in larger European economies which were more heavily exposed, such as France and Germany.

UK banks' combined claims on France and Germany represents nearly 130 percent of their core Tier 1 capital and close to half of that are claims on banks. In the event of severe stress in the 17-nation economy, the risk of losses to UK banks could increase, the central bank cautioned.

"Any escalation of stresses could also be transmitted via interconnected global markets, including via the United States, leading to a tightening of bank funding conditions," the FPC said. "Such contagion could be amplified if bank creditors were unsure about the resilience of their counterparties."

The FPC gave six policy recommendations in its first meeting that urged the Financial Services Authority (FSA) to ensure that improved disclosure of sovereign and banking sector exposures by major UK banks become a permanent part of their reporting framework. The financial services watchdog is also asked to compile data on the current sovereign and banking sector exposures of other UK banks which are not subject to the stress tests.

Further, the committee advised UK banks to benefit from the periods of strong earnings to build capital so that credit availability is not constrained in periods of stress. Such capital building ought to improve resilience without jeopardizing lending, the report said.

The interim FPC was established in February this year as part of a major overhaul of the UK financial regulatory system. The reforms led to handing over most of the powers of the FSA to the Bank of England. The committee led by Bank of England Governor Mervyn King is set to meet at least four times a year. The next meeting is scheduled to be held on September 20.

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