Alert upgraded! Bank of England: AI deployment may spiral out of control, risking systemic shocks in the private credit market

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The Bank of England has issued a warning about the potential threats of artificial intelligence to financial stability, noting that the use of AI by financial institutions could rapidly expand and develop into systemic financial risks.

This risk has already appeared in the private credit market. The Bank of England partially attributed the recent wave of fund redemptions to investors’ concerns about the disruptive prospects of AI. Previously, the Bank of England has repeatedly warned about the potential destabilizing risks of AI, including that significantly overvalued assets could trigger wider financial stress. According to a Bloomberg report last month, Bank of England officials are considering including employment shocks caused by AI in the next round of bank stress test scenarios.

In the current assessment, officials pointed out that most UK financial institutions currently believe the potential risks of advanced AI outweigh the potential benefits, but as technology advances, this judgment is likely to change. "Financial firms’ willingness to expand advanced AI deployment is rising, and the associated risks may quickly increase," the Bank of England stated.

The risks are particularly pronounced in the payments and financial market sectors. AI may fail to adequately detect fraud, or make markets more susceptible to sharp fluctuations. In the private credit sector, investors’ concerns over the potential disruption from AI have triggered a recent wave of redemptions in retail funds. The Bank of England warns that this pressure may further spread to the broader private credit and private equity sectors, affecting refinancing and other credit links.

MFS Collapse Reveals Regulatory Blind Spots

The Bank of England's report refers to the collapse of specialist mortgage lender MFS, which resulted in several major banks suffering hundreds of millions of pounds in risk exposure losses. The Bank of England pointed out that the incident exposed multiple risks including "high leverage, loose underwriting standards, opacity, excessively optimistic valuations, and complex structures."

MFS mainly provided bridge loans and buy-to-let mortgage loans, and was not directly regulated by the Bank of England, though traditional banks that funded it came under its supervision. This incident has once again highlighted the issue of regulatory boundaries.

The Bank of England’s semi-annual systemic risk survey released the same day showed that data collection ended twelve days before the escalation of tensions in the Middle East. Even so, geopolitical risk has reached a historic high in the survey, though respondents remain confident in the overall stability of the UK financial system.

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