The Bank of England warned today that the economic outlook for Britain and the world had darkened and told banks to ramp up capital buffers to ensure they can weather the storm.
"The economic outlook for the UK and globally has deteriorated materially," the Bank of England said as it published its latest Financial Stability Report.
It added that developments around the war in Ukraine would be a key factor.
International forecasters like the IMF and OECD say Britain is more susceptible to recession and persistently high inflation than other Western countries, all of whom are grappling with global energy and commodity market shocks.
British banks were well-placed to weather even a severe economic downturn, the Bank of England said, although it noted their capital ratios - while still strong - were expected to decline slightly in the coming quarters.
Members of the Financial Policy Committee (FPC) confirmed that the Bank of England will double the counter-cyclical capital buffer (CCYB) rate to 2% July next year.
They also said it could vary the rate in either direction depending on how the global economy pans out.
The CCYB rate represents an extra buffer for banks that varies depending on the economic outlook.
Despite a worsening cost-of-living crunch, with inflation heading towards double digits, the Bank of England said banks were resilient to debt vulnerabilities among households and businesses.
The central bank also expressed unease over the health of core financial markets which were the subject of the March 2020 "dash for cash" when the Covid-19 pandemic prompted panic selling.
"Amid high volatility, liquidity conditions deteriorated even in usually highly liquid markets such as U.S. Treasuries, gilts and interest rate futures," the Bank of England said.
It noted that core British markets - while still functional - had become more expensive to trade, with bid-ask spreads on short-dated gilts more than doubling compared with their 2021 average.
"Conditions could continue to deteriorate, especially if market volatility increases further," the bank said.
The Bank of England also said it would conduct an in-depth analysis of the functioning of the commodities market, with metals trade severely disrupted in March by Russia's invasion of Ukraine.
The central bank said it would begin its 2022 stress test of banks - delayed due to the war - in September, with the results likely to come in the middle of 2023.
