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\t\t\t<\/p>\n\t\t\tThursday 04 December 2025 12:02 pm\n\t\t\t<\/p>\n
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What keeps you up at night? For the governor of the Bank of England it\u2019s a long list of threats to the UK\u2019s financial system \u2013 so let\u2019s take a look at them. <\/p>\n
The Bank of England\u2019s latest financial stability report<\/a> makes for a sobering read. It says \u201crisks to financial stability have increased during 2025\u201d and that \u201cglobal risks remain elevated and material uncertainty in the global macroeconomic outlook persists.\u201d<\/p>\n So what are these threats?<\/p>\n The Chancellor may have avoided a messy bond market reaction to her Budget, for now, but there\u2019s something else lurking in the deep waters of government debt that has Bank of England officials worried: hedge funds. Specifically, leveraged trading in the gilt repo markets. What\u2019s that? Well, simply put, this refers to the practice of hedge funds and other asset managers arranging short term loans using their holdings of UK government debt as collateral.\u00a0<\/p>\n \t\t\t\t\t\t And hedge funds, in fact a small number of US hedge funds, have increasingly taken out enormous bets on small price fluctuations in the UK bond market<\/a>, which they then borrow against and reinvest to boost returns. The arrangement tends to suit all parties as government debt is seen as a safe bet.\u00a0<\/p>\n However, the Bank of England is worried about what would happen if those hedge funds suddenly needed cash in response to a shock elsewhere and had to liquidate their holdings of UK bonds. As the Bank put it:<\/p>\n \u201cForced or widespread deleveraging would have the result of amplifying initial moves and potentially triggering a feedback loop of further forced selling.\u201d<\/p>\n Chaos in the bond markets<\/p>\n They warn that the world is a dangerous place and that there are plenty of possible shocks in the future that could force a fire sale of UK debt that, in turn, could cause havoc in the bond markets, forcing up the cost of borrowing.<\/p>\n The amount of debt taken out against UK gilts has reached its highest level since the central bank started monitoring the trend in 2017. Hedge funds used their gilt portfolios to borrow some \u00a3100bn of extra cash in November, a pattern of behaviour the Bank said \u201cincreases the risk of sharp moves\u201d in the UK government bond market.<\/p>\n Officials are so worried about this that they\u2019re now exploring plans to limit the size of hedge fund bets on gilts in a bid to avoid the worst of any market fallout.<\/p>\n Next up, growing concerns about so-called shadow banking \u2013 private credit. This refers to lending and financing by financial institutions that are not banks. A business could get a loan from HSBC or Barclays or it could get that loan from a private debt fund or an asset manager like Blackstone or Apollo, or even the private credit wing of banks.<\/p>\n \t\t\t\t\tRead more<\/p>\n \t\t\tBank of England sounds alarm on leveraged hedge fund bond bets<\/a><\/p>\n Watchdogs across the world have become increasingly worried about the opaque role that private markets play in the global financial system, after a string of high-profile corporate collapses with ties to private lending. And these shadow banks are not regulated like traditional lenders.<\/p>\n $2 trillion shadow banking risk<\/p>\n The International Monetary Fund devoted a chapter of its 2024<\/a> financial stability report to the systemic threat posed by the private credit industry, which now boasts an estimated $2 trillion under management. Bank of England governor Andrew Bailey has also compared some of the riskier lending issued by industry players to the sub-prime mortgage crash that foreshadowed the 2008 financial crisis, saying \u201calarm bells\u201d were ringing<\/a>.<\/p>\n Officials warn that: \u201cUK banks are estimated to have \u00a3173 billion of banking book exposures to private market funds and corporates backed by financial sponsors, including private equity funds.\u201d So what are they doing about this risk? Well, they\u2019re going to start subjecting private credit providers to the same kind of \u2018stress tests\u2019 applied to traditional banks, where they\u2019re required to demonstrate their resilience to a range of hypothetical risks and shocks to see if they could withstand them.<\/p>\n AI stock market bubble burst?<\/p>\n Another area of concern reiterated by the Bank of England is the runaway valuations of AI companies and the risk of a stock market bubble bursting. They said many equities \u201cremain materially stretched\u201d and drew comparisons to the dot-com bubble and the global financial crisis.<\/p>\n The report warns of the risks of a \u201csharp correction\u201d in the sector and of the various ways in which the UK economy \u2013 and UK market \u2013 is exposed to this risk, saying \u201cas an open economy with a large financial centre, the UK is exposed to global shocks, that could transmit through multiple, interconnected channels,\u201d<\/p>\n It also gave a stark warning on the role debt financing was playing in the AI sector.<\/p>\n Bad actors and cyber threats<\/p>\n And to end on a cheerful note, the Bank also said that cyberattacks remain a critical threat to financial stability. Andrew Bailey said it\u2019s a risk that \u201cnever goes away\u201d and that \u201cYou can\u2019t mitigate cyber risk in a way that just takes it off the table.\u201d The report highlighted recent attacks on \u201cretailers and carmakers\u201d \u2013 aka, M&S and Jaguar Land Rover, and warned of \u201cbad actors out there in the world economy.\u201d<\/p>\n So, from vulnerabilities in the bond market to a booming and lightly regulated private credit industry to rogue states and cyber attackers, the risks are real and they\u2019re growing and getting more complicated. Fortunately, being alive to these risks is the first line of defence. The question, as we approach the end of this year, is whether anything happens next year that turns these risks into active threats.<\/p>\n UK government presents its own risk<\/p>\n Finally I should point out another critical risk to our stability, wealth and wellbeing: this government. The Consultancy Oxford Economics this morning released its own \u201cKey Themes for 2026\u201d document and it\u2019s not pretty. <\/p>\n They forecast a growth rate of just 1 per cent next year \u2013 abysmal \u2013 and they expect that \u201cmarkets will increasingly question the fiscal credibility of the Budget and the survival of the Labour leadership\u201d adding \u201ca slow burn of a steepening yield curve and weaker sterling could morph into a more serious confidence crisis\u201d \u2013 a risk heightened by the fact that the UK \u201clacks a sustainable growth driver\u201d \u2013 meaning that \u201cprospects for the private sector remain poor, consumers face a sharp slowdown in real income growth in 2026\u2026and the jobless rate will rise further.\u201d<\/p>\n The Christmas holiday can\u2019t come soon enough.<\/p>\n \t\t\t\t\tRead more<\/p>\n
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