The Governor of the Bank of England, Andrew Bailey, has a lengthy and worrying list of concerns keeping him awake at night, according to the central bank's latest sobering assessment. Its Financial Stability Report, published on Thursday 4 December 2025, states clearly that risks to the UK's financial stability have increased during 2025, with global dangers remaining high and economic uncertainty persisting.
Hedge Funds and the Looming Gilt Market Threat
While the Chancellor's recent Budget avoided an immediate bond market upset, a deeper, more systemic threat is brewing. The Bank has sounded the alarm over the activities of hedge funds, particularly a small group of US funds, in the gilt repo market. Here, these funds use their holdings of UK government debt as collateral to take out massive, leveraged bets on tiny price movements.
This practice has surged, with hedge funds borrowing an extra £100 billion in November alone against their gilt portfolios. The total debt secured against UK gilts is now at its highest level since monitoring began in 2017. The Bank fears that if a global shock forced these funds to raise cash quickly, a fire sale of UK bonds could trigger a dangerous feedback loop of forced selling, amplifying market moves and causing chaos, ultimately pushing up borrowing costs for the UK.
In response, officials are now actively exploring plans to limit the size of such hedge fund bets to prevent severe market fallout.
The $2 Trillion Shadow in the Banking System
Another major area of concern is the rapid, opaque growth of private credit, often termed 'shadow banking'. This refers to lending by non-bank institutions like private debt funds, asset managers such as Blackstone and Apollo, or the private credit arms of banks themselves.
This sector, now estimated to manage a staggering $2 trillion globally, operates with far less regulatory scrutiny than traditional banks. The International Monetary Fund has highlighted it as a systemic threat. Governor Bailey has even compared some of its riskier lending to the sub-prime mortgages that sparked the 2008 crisis, stating that "alarm bells" are ringing.
The Bank notes that UK banks have approximately £173 billion of exposure to private market funds and their backed companies. To address this, regulators will begin subjecting major private credit lenders to bank-style stress tests to gauge their resilience to economic shocks.
AI Bubble and Unending Cyber Threats
The report also reiterates warnings about stretched stock market valuations, specifically in the artificial intelligence sector, drawing parallels to the dot-com bubble. It cautions that a "sharp correction" is a real risk. As an open economy with a major financial centre, the UK is highly exposed to such a global shock, which could transmit through multiple interconnected channels.
Finally, on a persistently grim note, the Bank underscores that cyberattacks remain a critical, unending threat to financial stability. Bailey emphasised this risk "never goes away" and cannot be fully mitigated. The report pointed to recent attacks on major firms like Marks & Spencer and Jaguar Land Rover as evidence of the constant danger from "bad actors" in the global economy.
Government Policy Adds to the Gloom
Adding to the precarious outlook, analysis from Oxford Economics released the same morning forecasts just 1 per cent growth for 2026 and warns of a potential crisis of confidence in the government's fiscal plans. They suggest markets may increasingly question the Labour leadership's budget credibility, potentially leading to a steeper yield curve, a weaker sterling, and a rising jobless rate, exacerbated by the UK's lack of a clear sustainable growth driver.
From bond market vulnerabilities and a booming shadow banking sector to speculative AI valuations and cyber threats, the risks to UK financial stability are not only real but are growing and becoming more complex. Vigilance, as the Bank concludes, is the essential first line of defence.
