Britain's financial system is becoming more and more "vulnerable" because of major bodies increasing their risk-taking, the Bank of England has warned.
Publishing its financial stability report today, the Bank suggests that an "abrupt change" to market conditions could trigger serious consequences because of the heightened dangers.
The growing use of credit risk transfer markets, leveraged corporate lending and financial innovation have been caused by the "resilient" nature of Britain's financial systems but the compensation for bearing these risks remains low, the report warns.
"Financial markets have continued to be vibrant, core institutions are highly profitable and the economic outlook is favourable. But risk-taking is increasing," the Bank's deputy governor for financial stability, John Gieve, commented.
"Risk managers need to further develop ways of measuring and managing these new forms of risk," he added.
The report also warns that weaknesses in the US sub-prime mortgage market and a 60 per cent increase in the number of UK individuals becoming bankrupt or entering an individual voluntary arrangement in 2005 "could provide a warning of corporate stress to come".
"Strong lending and associated asset price growth support returns, increasing pressures to originate new loans," it explains.
"While this process continues in an apparent virtuous spiral, confidence is sustained and default rates stay low. But as default rates rise, confidence in credit quality can quickly be undermined as models break down. There is a risk that this dynamic could occur in other markets."
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