BoE Warns Financial Stability Risks Surge as AI Bubble Grows

The Bank of England has warned that risks to the UK’s financial system have risen substantially this year, citing overstretched valuations in artificial intelligence investments, risky lending practices and an unprecedented level of leveraged activity in government bond markets.

The assessment, released Tuesday in the central bank’s half-yearly Financial Stability Report, reinforces a series of recent warnings from Governor Andrew Bailey and senior policymakers.

Despite unveiling the first cut to bank capital requirements since the 2008 global financial crisis, the BoE said heightened geopolitical tensions, trade fragmentation and mounting strains in sovereign debt markets pose new challenges for financial stability.

Bailey told reporters that governments face growing fiscal pressures which may limit their ability to respond effectively to future shocks.

While the UK banking sector remains well capitalised and corporate and household indebtedness is relatively low, the central bank highlighted rising risks from abroad and from highly interconnected areas of financial markets.

Investor appetite for AI-linked companies has driven valuations in the United States to their most stretched levels since the dotcom bubble, and in the UK to their highest point since the global financial crisis.

The BoE warned that deepening links between AI firms and credit markets could create spillover risks if a correction occurs.

Bailey noted that even if AI delivers long-term economic benefits, not all currently high-priced firms will emerge as winners. This, he said, leaves lenders exposed should sentiment shift abruptly.

Regulators also pointed to recent corporate failures, including US car parts maker First Brands and dealership and lender Tricolor, as potential early signs of broader vulnerabilities. In response, the BoE will carry out a dedicated stress test later this week examining the resilience of the private markets ecosystem.

Bailey emphasised the importance of firms modelling scenarios where losses are more severe or more correlated than historic patterns suggest.

His remarks drew a response from the British Private Equity and Venture Capital Association, which argued that private capital has demonstrated resilience across multiple economic cycles.

BVCA Chief Executive Michael Moore said the sector had been a central pillar of UK economic growth for more than four decades.

Another point of concern for the central bank is the record level of leveraged activity by hedge funds in the gilt repo market.

The BoE noted that exposure approached 100 billion pounds last month, dominated by a handful of primarily US-managed funds reliant on frequent refinancing.

Officials warned that this concentration poses potential vulnerabilities should funding conditions deteriorate.

The warnings come at a time when the BoE is attempting to balance financial-stability oversight with support for economic growth.

Although banks are well placed to withstand shocks, the combination of elevated market exposures, geopolitical uncertainty and pressures on government finances has created a more fragile backdrop.

The central bank’s latest assessment underscores a more cautious tone for 2026, with policymakers preparing for the possibility that global stresses could intersect in ways that test the resilience of the UK financial system more severely than in recent years.