Increased borrowing by investors in equity markets has raised the risk of a sharp fall in prices that could threaten the stability of the financial system, the Bank of England warned Tuesday.

In its twice-yearly report, the BOE's Financial Policy Committee said steps towards securing a lasting resolution to the conflict between the U.S. and Iran had helped reduce, but not eliminate, some threats to stability.

"The signing of the Memorandum of Understanding has led energy prices to fall back to just above pre-conflict levels, reducing near-term risks," the BOE said. "However, substantial uncertainty remains and energy prices and interest rate markets have remained volatile."

The FPC said that many of the threats to the system it had previously highlighted have intensified, and noted the increased use of leverage by investors building stakes in AI-related companies.

"There has been a significant rise in hedge fund leverage in equity markets, creating risks, including via the prime brokers that facilitate this activity," the BOE said.

The U.K.'s central bank said the use of leverage could accelerate declines in equity prices should investors encounter a setback, such as disappointing revenues for providers of AI-generated services.

The BOE said hedge funds which also invest in government bonds could face pressure to sell those assets, broadening the impact of the setback.

While a range of setbacks is possible, including a fresh intensification of the U.S.-Iran conflict, the BOE highlighted the risks involved in meeting the historically unprecedented levels of investment needed to develop AI, and high levels of uncertainty about future revenues.

"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 said.

Late last month, the Bank for International Settlements warned that fierce competition to dominate artificial intelligence risks driving investment spending to excessive levels, threatening the profitability of leading firms.

The FPC also highlighted the risks posed by new AI models such as Anthropic's Mythos and those being developed in China, which can find cybersecurity bugs in companies' systems. The BOE worries that the new models can find vulnerabilities in bank software faster than fixes can be developed.

"The threat issue is a really major step forward," said BOE Gov. Andrew Bailey in a news conference. "We are heavily engaged on this question. We're working very closely with the banks."

The European Central Bank Tuesday called on banks in the eurozone to present a plan of action to address the increased threats posed by new AI models by October 31.

"This is a long-term shift in the threat landscape rather than a temporary phenomenon or a risk tied to any single tool," the ECB wrote in a letter to bank chiefs.

The FPC also said it is preparing changes to the rules that govern how much capital U.K. banks must set aside against potential losses.

"The reforms will address unintended consequences in the leverage framework and strengthen the releasability and usability of buffers," the BOE said.

However, some members of the FPC worried that easing some constraints on banks may boost their borrowing, encouraging precisely the kind of behavior they have warned against.

"Some FPC members were concerned the proposal might lead to an unwanted increase in market-based leverage," according to a record of the June meeting that considered the proposed changes.

The FPC said it will further investigate whether the proposed changes would "leave any financial stability gaps that would need to be managed."

Write to Paul Hannon at paul.hannon@wsj.com

(END) Dow Jones Newswires

July 07, 2026 08:08 ET (12:08 GMT)

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