The Bank of England’s Financial Policy Committee has issued a warning that risks to the UK’s financial stability have increased, citing a range of emerging threats including developments in artificial intelligence (AI) and renewed tensions in the Middle East. In its latest assessment, the committee identified growing interconnected vulnerabilities that have heightened the likelihood of a financial disruption since its previous meeting in June.
The Bank highlighted two primary concerns related to AI: cybersecurity risks and market vulnerabilities. On cybersecurity, the committee noted several recent incidents involving frontier AI models that have demonstrated how, without stringent safeguards, increasingly autonomous systems could exploit security weaknesses or operate beyond their intended scope. This poses a significant risk to financial institutions such as banks and insurers as they integrate AI technologies, potentially exacerbating operational challenges and security exposures.
From a market perspective, the Bank pointed to the sharp decline in AI-related stocks in July, which forced leveraged investors to unwind positions, amplifying market volatility. Despite this sell-off not triggering wider financial instability, elevated leverage levels among hedge funds and still-high valuations in the AI sector raise concerns. The committee warned that any significant downward revision in investors’ earnings expectations related to AI developments or adoption could precipitate a rapid market repricing.
Debt markets also face pressure as AI companies have increasingly turned to borrowing to finance ambitious technology advancements. As of September, these companies had issued approximately $450 billion in debt this year, surpassing the expected £330 billion of UK government bonds to be sold over 2026. The Bank expressed caution regarding the complexity and opacity of some financing arrangements, including circular financing structures where funding loops between investors and companies, complicating risk assessment and potentially magnifying losses if earnings fall short.
The geopolitical landscape has also affected financial stability concerns. Although tensions in the Middle East had eased earlier in the year, the recent escalation of conflict between the United States and Iran has led to higher prices for oil, gas, and refined products, contributing to a sustained negative supply shock for the global economy. This development has in turn driven sovereign bond yields across several advanced economies to levels not seen since 2008. The financial system has remained resilient so far amid government bond market turbulence but the committee underscored that risks persist, particularly given elevated hedge fund leverage and the growing complexity of market linkages.
Private equity and credit markets, which have expanded from $3 trillion to $11 trillion in the last decade, were also flagged as areas of concern. The Bank reaffirmed worries about asset quality and underwriting standards, noting that risk-taking remains elevated and that rising interest rates may increase debt servicing challenges for leveraged borrowers, especially those reliant on floating-rate instruments prevalent in these markets.
The committee recalled its July decision to relax the leverage ratio capital requirement for commercial banks to support lending growth, despite internal reservations about potential unintended market leverage increases. Following further analysis, the Bank confirmed it would proceed with this reform while advancing complementary measures to safeguard the gilt repo market, with detailed proposals expected early next year. Additional supervisory efforts by the Bank’s Prudential Regulation Authority aim to enhance risk management in prime brokerage activities, ensuring that risks from banks’ market leverage provisions remain controlled.
The Bank concluded that if risks intensify, it would consider raising the general leverage ratio buffer beyond the current 25 basis points to bolster financial resilience.