The Bank of England has warned the European debt crisis is a "key risk" to the British banking sector and says banks should build up their cash reserves in response.
In its latest report on financial stability, the bank welcomed recent measures taken by the EU to stem the crisis.
But it said the exposure of British banks to other European lenders made them vulnerable.
Investors remain concerned that some eurozone countries risk defaulting.
Market expectations of a default by Greece rose to an all-time high on Thursday.
The BoE said sovereign debt concerns have raised doubts about the strength of some European banks, which could have a knock-on effect on the UK financial sector.
The BBC reports that UK banks have relatively little direct exposure to Greece and other crisis-hit European governments.
However, the Bank of England indicated that indirect exposures were substantial.