Britain's financial markets could be severely damaged by a sudden economic downturn as comfortable market conditions have encouraged them to extend levels of risk, the Bank of England has warned.
Publishing its financial stability report today, the Bank acknowledges the "remarkably resilient" nature of the UK financial system before arguing that "plausible but unlikely" events like a bird flu pandemic or an explosion of personal debt could have catastrophic results on the British economy.
The report highlights six areas of special concern, which cover vulnerabilities in international markets, the sudden development of debt in non-financial sector balance sheets and the increasing risk associated with reliance on existing financial structures, institutions and utilities.
Looking ahead, the report notes that "the evolution of risk within the system in the period ahead will depend on the future behaviour of financial firms and investors".
"Recent market volatility has reminded investors and firms of the financial risks they are running. But it remains an open question whether it has changed decisively the perceived balance between financial and business risks."
Commenting on the publication of today's report, Sir John Gieve, the Bank's deputy governor for financial stability, explained that "the pace of innovation and growth of financial markets is raising the bar".
"Firms need to continue to improve their stress testing against less favourable conditions," Sir John said.
"We are working with the FSA and Treasury and authorities abroad to mitigate the risks and improve contingency planning."