LONDON: The Bank of England - the UK equivalent of the US Federal Reserve - on Thursday issued a warning of unusual severity, cautioning that the nation's financial system faces its most serious challenge in decades.

According to the Bank's biannual Financial Stability Review, financial institutions have become more fragile and the availability of credit may tighten.

It also warns that tighter lending conditions could spell serious fallout for the economy, with subprime borrowers and highly-leveraged companies especially vulnerable.

Investors are cautioned that UK and US share prices could prove "vulnerable to any further revision in growth prospects". Moreover, the dollar could dive if adverse sentiment towards US securities persists.

BoE deputy governor Sir John Gieve concedes that although the bank had expected some of the problems in recent weeks, "the speed and ferocity [of the global tumult] had not been anticipated by firms or authorities".

"Serious fragilities" had been exposed within the so-called 'originate and distribute' business model used by many financial firms to parcel up debt, a situation that "has proved to be the most severe challenge to the UK financial system for several decades."

British banks are especially vulnerable. They face a collective bill of almost £150 billion ($307.37bn; €215.89bn) if the credit crisis forces them to set aside capital against their exposure to structured investment vehicles, leveraged loans and mortgage-backed securities,

Noting the high levels of borrowing by the commercial property sector, the review fingers that market as "particularly prone to shocks and to rises in the cost of finance", and the bank calls for the UK's crisis management tools to be strengthened.

Data sourced from The Times (UK); additional content by WARC staff