FPC warns of rising risks from leverage, AI, and sovereign debt

The Bank of England's Financial Policy Committee (FPC) highlighted persistent vulnerabilities in risky asset valuations, sovereign debt, and private credit markets. The July 2026 Record noted a substantial increase in leverage within equity markets and new financial stability risks from frontier AI capabilities.

Leverage fuels equity and AI debt

The FPC highlighted persistent vulnerabilities in risky asset valuations, sovereign debt, and private credit, noting some have become more pronounced since December 2025.

A substantial increase in leverage in equity markets is a key concern, partly driven by a narrow set of AI-related companies.

Equity prices, especially for AI stocks, have risen, with valuations becoming stretched.

Hedge fund leverage in equity markets has significantly increased, creating risks through prime brokers and interconnected markets.

AI-related companies' use of credit markets, including public, private, leveraged, and structured finance, has accelerated rapidly, a historically unprecedented pace of investment.

The FPC is concerned about the increasing complexity and opacity in debt structures used by AI-related companies, which could increase risks to financial stability.

The Middle East conflict initially caused a substantial negative supply shock and market volatility, but a recent Memorandum of Understanding has reduced near-term risks, though uncertainty and volatility persist.

Resilience tested by AI and global shocks

Rapid advances in frontier AI capabilities have significantly increased financial stability risks from cyber and operational vulnerabilities.

While AI offers opportunities to improve cyber defence, it will also increase the sophistication and impact of cyber-attacks.

Operational risks are likely to increase as AI accelerates vulnerability discovery, requiring firms to identify and mitigate issues more quickly.

Global sovereign bond market issuance is at historically high levels, with debt-to-GDP ratios trending upwards, raising risks of increased volatility and reducing governments' capacity to respond to future shocks.

Any negative change in expectations regarding AI's impact on debt sustainability could have wider consequences.

Despite these challenges, the UK financial system has remained resilient, continuing to support the real economy.

UK household and corporate aggregate indebtedness remains low, and the UK banking system is appropriately capitalised with high levels of liquidity.

The FPC maintained the UK countercyclical capital buffer (CCyB) rate at its neutral setting of 2%.

New risks, old vulnerabilities

The FPC's record paints a picture of a financial system grappling with a complex mix of escalating new risks and persistent old vulnerabilities.

While the UK system shows resilience, the committee's emphasis on simultaneous crystallization of risks from AI, leverage, and sovereign debt highlights a growing systemic fragility.

The ongoing review of bank capital and the CCyB's neutral setting are prudent, but the underlying market dynamics demand more proactive, rather than merely reactive, policy responses.