The Bank of England warns today that risks remain in the global financial system, with an economic downturn under way and "signs of distress" in emerging market economies.

It notes "mark-to-market" losses on securitised credit instruments and corporate bonds in the UK, eurozone, and US have more than doubled since its previous financial stability report six months ago to $2.8 trillion (£1.8 trillion).

However, it declares recent radical government action, starting in the UK and followed in other countries, has raised banks' capacity to withstand further losses.

Its latest comments come amid continuing volatility in global stock markets.

The UK stock market gyrated wildly yesterday. The FTSE-100 index of leading UK shares was down as much as 218.15 points yesterday morning, after another bad session in Asia which saw a further 6% slide in Japan's Nikkei 225 average.

Fears of global recession overshadowed further easing of interbank lending rates during morning trading in London.

The Footsie recovered during afternoon trading, amid a firmer tone on Wall Street, and showed a 28.25-point gain at one stage. It ended 30.77 points lower at 3852.59.

Sterling was pushed close to fresh six-year lows against the dollar, falling to $1.5280. This was only a hairsbreadth above its six-year low of $1.5270 on Friday. As on Friday, the pound yesterday rebounded. Sterling was last night trading close to $1.57 - down about 1.5 cents on its Friday close in London.

After a volatile session on the US stock market, the Dow Jones Industrial Average closed 203.18 points lower at 8175.77.

Mulling the state of global stock markets, Scottish Investment Trust manager John Kennedy said: "It could be a long, slow bottoming process as the market digests the stream of weakening economic indicators, confirming the recession."

Sterling and euro interbank lending rates, on borrowing of more than one week's duration, eased yesterday. Dollar rates eased across the board.

The British Bankers' Association's London Interbank Offered Rate for three-month sterling fell from 5.98% on Friday to 5.95375% yesterday. The overnight sterling rate rose from 4.75% to 4.8125%.

The three-month sterling rate is still nearly one-and-a-half percentage points above the UK base rate of 4.5%. A further cut in base rates of at least half-a-point is forecast by November 6 - when the Bank of England's Monetary Policy Committee is due to conclude its next two-day meeting.

Publishing its latest bi-annual financial stability report today, the Bank of England says: "With a global economic downturn under way and growing signs of distress among some emerging market economies, the report notes that risks remain in the financial system."

Sir John Gieve, deputy governor of the Bank with responsibility for financial stability, highlights the scale of the current crisis and the remaining risks but also cites signs that moves by the UK government to recapitalise banks and guarantee new short and medium-term debt issuance by institutions are bearing fruit.

He says: "The instability of the global financial system in recent weeks has been the most severe in living memory. And with a global economic downturn under way, the financial system remains under strain.

"But it is better placed as a result of the exceptional package of capital, guaranteed funding and liquidity support. That is helping to underpin the banking system both directly and by demonstrating the authorities' determination to do whatever is needed to restore confidence."

The Bank notes its report "highlights that, over the medium term, banks will need to adjust their balance sheets and funding models, weaning themselves off current levels of official sector support".

Gieve highlights the need to regulate to try to prevent a recurrence of the crisis, including measures to try to dampen the financial cycle. He says: "Looking further ahead, we need a fundamental re-think of how to manage systemic risk internationally. We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers they bring to the wider economy.

"That means not just increasing capital and liquidity requirements for individual institutions but relating them to the cyclical growth of risk in the system more broadly. Counter-cyclical policy of that sort should complement regulation of companies and broader macroeconomic policy."

The stability report declares the global banking system has in recent weeks "arguably undergone its biggest episode of instability since the start of World War I".

It says: "Benign international macroeconomic conditions contributed to an extended global credit boom, with financial institutions, including UK banks, rapidly expanding their balance sheets, accompanied by sharp increases in banks' leverage as financial innovation and a search for yield encouraged risk-taking and risk distribution across borders increasing connections across financial systems with lending increasingly financed from wholesale funding, often from overseas."

The report adds: "Given a weakening of asset quality and funding structures, banks in the United Kingdom and internationally were vulnerable to credit and liquidity risks. These risks crystallised as the macroeconomic outlook weakened and housing markets deteriorated in several countriestranslating into further, more broadly-based, losses on many institutions' asset portfoliosand increasing uncertainty about future potential losses on lending."

The Bank notes that "estimated mark-to-market losses have more than doubled since the previous report, and now total some US$2.8 trillion".

It adds: "This is equivalent to around 85% of banks' pre-crisis Tier 1 capital globally of US$3.4 trillion, though only some of these market value losses are directly borne by banks."

The Bank notes three key phases of "institutional distress". It recalls that the problems started at US mortgage companies Fannie Mae andFreddie Mac, which were bailed out by the US government in September, and spread quickly to US securities houses, notably Lehman Brothers.

The Bank adds: "The second phase of the turmoil involved rapidly rising stress across funding and other financial markets Lending maturities in the interbank market were shortened, with many banks and other institutions only able to borrow overnight. Three-month Libor spreads over official rates hit new highs."

The Bank highlights measures globally to aid wholesale funding markets by boosting liquidity, but notes these failed to prevent a "spillover of distress" and led to moves including the UK government's facilitation of Bank of Scotland and Halifax parent HBOS's takeover by Lloyds TSB.

It says the "broad-based spillover of distress...led to the third, and most violent, phase of the turmoil, with system-wide financial sector fragilities emerging internationally", and adds: "In response, governments facilitated bank mergers or nationalised firms to stabilise the banking system. In the United Kingdom, Bradford & Bingley was partly nationalised, Alliance & Leicester was taken over by Banco Santander and Lloyds TSB instigated an acquisition of HBOS."

Meanwhile, amid much speculation about the insurance sector, the Bank says: "Insurance companies seem relatively well placed to avoid liquidity difficulties."

It adds: "Risks could arise, however, if the value of insurance companies' investments were to fall below regulatory capital requirements. This was an issue in the bear market of 2003, but regulatory reforms introduced in 2004 have reduced the likelihood of this risk by using a more risk-based capital requirement with counter-cyclical resilience testing.

"A second risk is that credit ratings of insurance companies could be downgraded. Counterparts to any derivatives trades would then increase margin requirements, increasing the liquidity needs of the insurance sector."