The Bank of England said financial stability risks increased over the course of 2025, highlighting stretched equity valuations tied to artificial intelligence companies, growing vulnerabilities in private credit markets and heightened leverage in government bond trading strategies. In its half yearly assessment, the central bank noted that while Britain’s banking sector remains well capitalised and household and corporate indebtedness appear manageable, several external pressures are building across global financial systems. Officials pointed to geopolitical tensions, trade fragmentation and sovereign debt concerns as key sources of uncertainty. They said governments facing rising fiscal obligations may be less able to respond to future shocks, leaving markets more exposed to abrupt shifts in sentiment. The report also coincided with the BoE’s first reduction in capital requirements for banks since the financial crisis, underscoring a divide between strong balance sheets in the regulated sector and growing fragilities elsewhere. Policymakers stressed the need for firms to prepare for scenarios where losses become more correlated, particularly in areas linked to technology funding and credit exposures.
A significant portion of the central bank’s focus centered on AI related assets, where valuations in the United States and the United Kingdom have climbed to levels not seen since major speculative cycles of earlier decades. The BoE warned that increased interconnectedness between AI firms, lenders and investors could amplify losses if prices reverse. Officials cited recent corporate failures as early signals that broader stress could emerge within private credit markets, where lending practices have grown more complex and less transparent. The central bank plans to conduct a stress test on private market ecosystems to evaluate resilience under more severe scenarios. Policymakers emphasized that firms should incorporate assumptions involving greater loss severity and higher correlations across exposures. Market observers noted that although private equity trade groups highlighted the sector’s longstanding resilience, the BoE’s assessment suggests that rapid growth in non bank finance has created pockets of vulnerability that may not be immediately visible.
The report also drew attention to hedge fund activity in the gilt repo market, where leverage reached record levels near one hundred billion pounds driven largely by a small number of overseas managed funds reliant on short term refinancing. The BoE said the scale of these leveraged positions poses a risk to market functioning if financing becomes strained, potentially triggering forced sales of British government bonds. Officials highlighted that the resilience of the gilt repo market is central to the stability of the broader sovereign bond market, which underpins financial activity across the United Kingdom. Although regulatory reforms in recent years strengthened the performance of liability driven investment strategies, the central bank warned that vulnerabilities remain and that participants must be prepared for shocks while longer term reforms such as expanded central clearing and higher margin requirements are considered. Policymakers reiterated that global sovereign bond markets face similar challenges as leverage, cross border positioning and refinancing dynamics continue to shape market behavior.
