Banking and Finance Law Daily Wrap Up, FINANCIAL STABILITY—FSB chairman sounds warning on risks from AI models, conflict-related disruptions, (Aug 31, 2026)

By Jeff Williams

The letter calls for "continued vigilance and international cooperation" as the financial system evolves and presents "significant opportunities."

Along with warning about potential market disruptions from the use of frontier artificial intelligence (AI) models, Financial Security Board (FSB) President Andrew Bailey has sent a letter to G20 finance ministers and Central Bank governors urging them not to be "complacent" that the financial system will be able to continue to "absorb the substantial supply shock to the global economy" caused by the conflict in the Middle East as prices remain "sensitive to news of the conflict" and financing costs have continued to increase amid valuations of "risky assets" remain elevated.

"Markets remain vulnerable to a potentially disorderly correction that could spread across borders, particularly given fragilities in sovereign debt markets (including elevated issuance, shortening maturities, and the increased use of leverage by some market participants); vulnerabilities in private credit (including levels of interconnectedness with other parts of the financial system, liquidity mismatch and opacity); as well as stretched asset valuations (particularly artificial intelligence-related investments)," Bailey said in the letter sent ahead of finance leaders attending G20 meetings this week in Asheville, North Carolina.

The use of leverage in equity markets has also become a concern that has "emerged more clearly in recent months," Bailey noted, pointing to greater use of leveraged exchange-traded funds (ETFs) and correlated momentum-driven investment strategies, including by retail investors. There is also a "growing footprint" of leveraged entities, such as hedge funds in equity markets that are exposed to sovereign debt, that expands the scope of the risk of contagion, he said.

"As we have seen multiple times in the past, rising leverage is a feature of a maturing financial cycle," Bailey wrote. "While it can reinforce rising markets, it can also intensify declines when sentiment turns, as recent weeks have demonstrated." The FCB chairman said that in addition to investors borrowing more, that leverage is "interacting with high valuations and market concentration, in particular the increasing cross-investment between artificial intelligence (AI) companies and hyper scalers, in a way that could amplify a future market correction." Bailey said he remains concerned that a "large shock or combination of shocks could concurrently trigger multiple vulnerabilities."

Frontier Models. With AI models displaying "increasingly sophisticated autonomy and problem-solving abilities, as well as threat capabilities," Bailey cautioned that the risk landscape has been further complicated. "The risks associated with frontier AI will not respect national borders," the letter said. "The global financial system is highly interconnected, and cyber disruption can spread across jurisdictions through common technology providers, shared infrastructure, and cross-border financial activity." Because of jurisdictional differences in legal frameworks, cyber capability, resilience and recovery capacity, there could be consequences from AI-related threats that reach "well beyond the jurisdiction in which an incident originates," he said.

The "most immediate concern," Bailey wrote, is the potential impact on cyber risks caused by frontier AI. "Frontier AI may have the ability materially to alter the speed, scale and economics of cyber risk, /which could undermine market confidence system-wide, especially due to highly concentrated third-party service providers," he said. Firms and authorities should be prepared for a "threat environment characterised by a higher volume of vulnerabilities and a faster pace of patching, recognising that these dynamics could themselves create operational and resilience challenges if change, testing and recovery processes are unable to adapt safely," Bailey said. Though frontier AI offers "significant opportunities" to strengthen cyber defense, "recent developments highlight the importance of ensuring that advances in capability are matched by resilience and preparedness," he said.

Financial institutions, financial market infrastructures, and technology providers need to "strengthen their vulnerability management, response and recovery capabilities, and prepare for more severe scenarios involving simultaneous disruption across multiple firms or shared technology dependencies," the letter said.

The FSB is exploring particular issues associated with the safe deployment of frontier models for cyber defense by financial services firms, along with ways to improve capabilities to respond to and recover from significant operational disruptions, Bailey said, adding that recent developments have "also highlighted to me that many jurisdictions do not have the protocols in place to manage the development, release, and deployment of advanced frontier AI models, heightening risks for the financial sector and beyond."

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