(Reuters) - Britain's banks are drawing up contingency plans in case there is a disorderly break-up of the euro zone or exit of some countries from the single currency as the sovereign debt crisis rages on, a top UK regulator said on Thursday.
Andrew Bailey, deputy head of the Prudential Business Unit at the UK's Financial Services Authority (FSA), said UK banks do not have large exposures to the euro zone, but must plan for the worst.
"We cannot be, and are not, complacent on this front," Bailey said at a conference. "As you would expect, as supervisors we are very keen to see the banks plan for any disorderly consequence of the euro area crisis.
"Good risk management means planning for unlikely but severe scenarios and this means that we must not ignore the prospect of a disorderly departure of some countries from the euro zone.
"I offer no view on whether it will happen, but it must be within the realm of contingency planning," he said.
Bailey, who was Chief Cashier at the Bank of England, moved to the FSA as part of preparations for a shake-up of UK financial supervision from 2013.
He will be deputy head of the new Prudential Regulation Authority which will be a subsidiary of the Bank.
Bailey has already held talks with Britain's banks, saying lenders needed little prompting, but the lack of a mechanism for a euro zone country to exit the currency made things more complicated.
"We have been talking to them already and we will be talking to them again and asking questions," Bailey added.
"There is no roadmap out there that says this is how it happens," Bailey later told reporters.
There is already rigorous testing of systems going on, including for a possible euro zone break-up, as part of an ongoing risk management process that has stepped up considerably in recent years, bankers told Reuters last week.
Banks are constantly testing their capital, liquidity and operations, such as payments systems, for risks and as the euro zone break-up threat has risen, that feeds into the checks.
Bank of England monetary policy committee member David Miles, said the euro zone crisis was already having a substantial impact on Britain by pushing up funding costs for banks and companies. He echoed Bailey's view that UK lenders were in a relatively strong position.
"But nonetheless they get sucked into some of the funding difficulties and that's already happened over the last four or five months," Miles told the Yorkshire Post newspaper on Thursday.
Scott Roger, a senior economist at the International Monetary Fund, said there was "phenomenal" scope for contagion risk across financial markets but there are few signs that regulators are coordinating even as the euro zone crisis deepens.
"National regulators still have a national champions view approach to banking," he told a Thomson Reuters IFR conference.
NOT JUST BANKS
A number of British firms, including budget airline easyJet and the world's biggest caterer Compass Group have said they have discussed or put in place contingency plans to deal with any collapse in the euro but many are reluctant to give details, perhaps reflecting the fact that there is little many of them can do.
Their best insurance policies are natural hedges in the form of the broadest possible customer base and exposure to the biggest possible basket of different currencies -- not something a company can change in a hurry.
"One of the great strengths of Compass is that we don't have an over-dependency on just one or two clients, we have 40,000 clients across the world," Chief Executive Richard Cousins told reporters earlier this week.
James Hickman, managing director at foreign exchange firm Caxton FX, said he strongly believed that countries would start to drop out of the euro zone, with Greece looking like a good first bet.
"Over the past few years, we have invested heavily in infrastructure, which enables us to adapt swiftly to any changes. For example, if Greece were to drop out of the euro today, we could very quickly add the drachma to our list of tradeable currencies," he told Reuters. "No-one can provide a definitive answer about what is going to happen to the euro and that's why we need to be prepared for any given situation."
DELEVERAGING
Bailey said the resilience of UK banks had improved substantially since the 2007-2009 near meltdown of the global financial system. "Today, UK banks are not front-and-centre of the problem," Bailey said.
The current phase of the crisis has not singled out UK banks as they do not have large direct exposures to the vulnerable euro zone countries.
UK banks were also forced to build up liquidity buffers ahead of the new Basel III global bank rules that take effect from 2013.
Bailey signalled flexibility on their use in the current stressed times for funding markets as policymakers want banks to continue lending to an already stumbling economy.
"These buffers should be used in times like the present... But they will need to be rebuilt," Bailey said.
He welcomed moves by banks to ditch non-core assets as it sent an important signal to investors, regulators and the public that lenders were committed to structural changes.
"Actions speak louder than words here. My best guess is that we will see a sharp reduction in the scale of investment banking activity undertaken in the banking sector," Bailey said.
One of his key worries was "disorderly" deleveraging seen at some banks in continental Europe as they race to meet temporary, higher capital buffers in a bid by the EU to shore up confidence in the sector.
"The UK banks are not experiencing the worst sort of deleveraging," Bailey said.
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