Bank of England Warns AI and Lending Pose Growing Financial Risks

The Bank of England (BoE) issued a sharp warning in its half-yearly Financial Stability Report, stating that overheating technology valuations, rapid growth in private credit, and increased leverage in gilt-repo markets have raised the risk of financial instability in the United Kingdom.

The BoE highlighted that valuations linked to artificial intelligence have accelerated beyond fundamentals, drawing comparisons to previous market cycles driven by speculative optimism.

The report said that a sudden correction in AI-linked assets could transmit losses through financial institutions exposed via equity financing, structured debt products, and lending tied to technology sector growth.

• Bank of England Flags AI Valuation Bubble and Rising Credit Risks
• BoE Warns AI Hype, Private Credit Growth and Leveraged Gilt Trades Threaten Stability
• Financial Stability Report Highlights Growing Market Vulnerabilities in UK

Separately, the central bank noted that hedge funds have increased their use of leverage in gilt-repo financing. Roughly £100 billion in positions are now built on short-term borrowing against government bonds, marking one of the steepest rises in recent years. The BoE said that sharp moves in the gilt market, a disruption in liquidity, or a shift in refinancing conditions could trigger forced selling, resulting in market disorder similar to the pension-fund stress seen in 2022.

The report also pointed to continued expansion in private credit markets, where opaque leverage, fewer regulatory safeguards, and rising refinancing needs have created vulnerabilities. The BoE said that these risks could amplify if economic conditions weaken or funding costs continue to rise.

Despite these threats, the central bank stated that the UK banking system remains well capitalised and able to absorb shocks. However, it stressed that stress points lie in markets outside traditional supervision.

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To address growing exposure, the BoE confirmed it will introduce targeted stress testing on private credit structures and leveraged gilt-repo activity to assess whether major institutions and funds could withstand a downturn without triggering broader disruption.