Will AI Market Growth & Opaque Debt Threaten UK Banks?

Traditional financial institutions have historically approached disruptive technological innovations with a degree of healthy scepticism, prioritising systemic safety over rapid adoption.

This cautious stance aligns with the Bank of England (BoE) new warning that AI poses a growing threat to financial stability as investors are betting heavily that the technology will prove a success. However, this simultaneously increases banks’ vulnerability to cyberattacks.

In a half-yearly assessment of risks to Britain’s financial system, the central bank says previous dangers it had identified have not gone away. These include stretched share price valuations, high public debt and risky private credit lending to businesses.

However, the BoE highlights additional dangers that have escalated since its last review. These include a potential stock market bubble, heightened cybersecurity vulnerabilities and AI companies’ increasingly complex and opaque debt.

The central bank notes that the likelihood of multiple vulnerabilities ‘crystallising at the same time has increased’. According to the report, this overlapping pressure is ‘potentially amplifying’ its combined impacts on financial stability.

Stretched market valuations 

For investors’ bets on AI to pay off, the BoE says there must be widespread profitable adoption of the technology. This requires the effective build-out of new infrastructure and easy access to finance for the sector.

The valuations of AI companies are currently based on earnings forecasts, which are ‘highly uncertain’, the report continues. 

Some of the world’s most valuable companies, like chipmaker NVIDIA, have seen their share prices soar as they invest in AI or benefit from market demand.

Those valuations have also become more stretched with the market rise partly driven by a narrow set of tech firms. The biannual report notes this is ‘increasing market concentration in some global indices’.

A sudden shift in investor sentiment regarding these businesses could trigger a sharp market correction. 

“A reassessment of these prospects could trigger a fall in equity prices that might be amplified by high concentration, correlated momentum-driven positions that can exacerbate volatility as markets fall, and increased leverage,’ the BoE says.

Opaque debt structures threaten stability

Corporate borrowing by tech infrastructure providers has increased rapidly, leading to a pace of investment that is ‘unprecedented historically’. 

The BoE highlights additional dangers from investors, including hedge funds, borrowing to buy shares alongside AI-related companies borrowing heavily to fund investments.

This rapid growth in leverage could pose a risk to financial stability due to ‘increasing complexity and opacity in debt structures’. A lack of transparency about how these entities borrow could worsen a financial crisis.

“Considerations around the future earnings potential for AI-related companies will also be relevant to the sustainability of these companies’ debt,” the BoE adds. If future earnings fall short of expectations, servicing this debt could become unsustainable.

The Financial Policy Committee (FPC) exists to ensure the UK financial system can handle economic shocks. It concluded the financial system has remained resilient and continues to support the UK economy.

Cyber risks escalate via advanced AI

Regulators globally have begun to focus more keenly on the operational impact of advanced technologies. 

These range from risks associated with frontier AI models such as Anthropic’s Mythos to the challenges posed by autonomous agentic systems.

Advanced AI models are ‘increasingly capable’ of launching cyberattacks at greater scale. This is due to ‘rapid progress’ in cutting-edge AI since the last financial stability report was published in December.

This technological progress presents a ‘significant increase’ in the risks to financial stability. 

It requires firms and authorities to revisit whether the resilience of key technology providers is sufficient.

In the report, the BoE says it is unclear if better AI strengthens the hand of attackers or those seeking to defend financial systems. However, it is likely to require more frequent software updates by financial firms, which themselves carry a risk of operational disruption.

Need for bespoke AI regulation

The rise of autonomous technologies has prompted senior central bankers to call for entirely new regulatory frameworks. 

Sarah Breeden, BoE Deputy Governor, signalled the need for bespoke AI regulation to contain risks posed by increasingly capable agentic systems.

“Our frameworks were not built to contemplate autonomous agents, and relying on a human in the loop for all agent actions is unlikely to be realistic,” Sarah says.

The FPC also questioned the basis for the anticipated economic benefits of using the technology, noting uncertainty over the scale and timing of future productivity gains. It remains unclear whether companies can consistently make money from AI applications.

However, the FPC adds that AI has the potential to increase productivity across a range of sectors. The technology could still support long-term economic growth, having already supported growth in some regions.