AI debt surge raises risk of sharp market correction, warns Bank of England

The Bank of England has warned the financial system is at risk of a “sharper correction” than happened over the summer because of the growing reliance on debt to fund the boom in AI infrastructure.

AI-related debt issuance totalled $450bn in the year to September, more than double all of last year, the BoE said in its quarterly update on financial stability on Wednesday, citing estimates by Morgan Stanley. Global AI-related debt sales are expected to exceed the amount of bonds sold by the UK government this year, it added.

“The rapid increase in artificial intelligence-related debt issuance broadens the exposure of capital markets to developments in AI,” the BoE’s Financial Policy Committee said.

Shares in AI-linked companies and semiconductor makers slumped in July before recovering as investors responded to concerns over the earnings potential of the technology.

The BoE said the “risk of a sharper correction persists” in financial markets, “notably if there is a more significant shock to earnings expectations reflecting concerns around the pace of AI development or adoption”. But it said the financial system had “so far been resilient”.

The FPC said if AI-driven productivity gains fail to boost economic growth as much as forecast, it would “affect not only AI-related asset valuations but also sovereign debt markets”.

Andrew Bailey, BoE governor, said in a blog published on Wednesday that regulators “cannot stand aside” and assume the AI industry will resolve the risks it presents to the stability of the financial system, including the most advanced models going rogue or being used for cyber attacks.

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However, Bailey said “we should not automatically turn to the question of regulation”, adding: “Understanding, testing and establishing credible points of intervention must come first.”

Overall vulnerabilities in the financial system have increased in recent months, the central bank said, blaming the war in Iran and subsequent surge in energy prices, persistent inflationary pressures, high government debt levels and rising interest rates.

It also warned that high borrowing, or leverage, at hedge funds to bet on UK government bond markets was intensifying the risks of a correction.

The central bank said it had agreed to proceed with a planned reduction in capital requirements on the UK banking system by easing the leverage ratio, which sets how much capital lenders need in relation to their total assets.

But it said this would lead to a “meaningful” increase in leverage banks provide to hedge funds for betting on government debt markets, which is already an area of concern for officials. Bank lending in gilt repo markets to hedge funds and other non-banks has already doubled to about £200bn since 2023, it said.

Therefore, the committee said it would examine “market-based measures” for gilt repo markets such as increasing the requirement to use central clearing or minimum haircuts, which limit leveragee, and publish its proposals early next year.