Promoting innovation while guarding against financial stability risks − speech by Randy Kroszner

Good morning everyone. It’s truly a pleasure to be here to talk to you today about one of the most pressing challenges facing policymakers and regulators across the globe: how to identify and manage emerging risks in the global financial system in a way that fosters growth and innovation, while remaining alert to the potential implications for financial stability.

The financial landscape is evolving rapidly – driven by technological advances, shifting market dynamics, and global interconnectedness. These changes bring tremendous opportunities, but they also introduce new vulnerabilities that demand our attention.

The task is clear yet complex: to promote sustainable economic growth and encourage innovation, while ensuring that the foundations of financial stability remain strong.

In my (long) career as a policymaker and regulator I have seen first-hand the shifts and changes in the financial system that give rise to these new opportunities and challenges.

I joined the Federal Reserve as a Governor in 2006, just before the Global Financial Crisis (GFC) erupted and battled the aftermath of that as we rebuilt much needed resilience into the banking system.

Since 2023, in my role as a member of the Bank of England’s Financial Policy Committee (FPC) I have scrutinised developments in the financial system with particular focus on their consequence for the financial stability of the UK. Additionally, in my role as a member of the Bank of England’s Financial Markets Infrastructure Committee (FMIC), I’ve witnessed the huge technological advancements of recent years. These are having their own considerable impact on the financial system.

This is not novel to the UK. Policymakers and regulators across the globe are grappling with an evolving global financial system, and how to navigate a path to safeguarding financial stability.

In this speech I would like to set out a ‘practical guide’ to promoting innovation while maintaining financial stability. This practical guide for supervisors and macroprudential authorities dealing with innovation has three stages.

• First: Understand the innovation – including what drives its value to the wider economy – and its impact on and interaction with the broader financial system.
• Second: Identify and assess potential risks, in the context of a cost-benefit analysis of benefits of the innovation vs its financial stability impacts.
• Third: Determine what policy response, if any, is appropriate, and stay alert to the potential for unintended consequences further down the line.

My focus here will be on the second stage of the process: to offer a practical framework for identifying and assessing the potential risks of an innovation, and the implications for financial stability. The framework involves breaking down the challenge of the new and unfamiliar into the more familiar channels of risk or “fragilities.” As I describe below, I argue that we can use three familiar channels of leverage, liquidity and interconnectedness. The lesson here is that while innovations may be new, the risk channels remain the same. The challenge is to apply these traditional risk channels or fragilities to new contexts.

I will then apply the framework to two specific examples which I think highlight the different ways in which innovation in the financial system can create new challenges. The first example, stablecoins, is the result of the profound technological transformation we are currently living through. The second – private credit – has emerged in the context of, and partly as a result of, the (very justified) post-crisis banking sector reforms and the rapid growth of non-bank financial intermediation.

Why we care about growth and innovation and why do they matter for financial stability

Promoting innovation and growth and promoting financial stability can be mutually reinforcing. After all, a safe and resilient financial system that reduces vulnerabilities to systemic events can provide the financial support for the real economy that is vital for sustainable growth. It provides a stable environment for consumers, customers and national economies to all reap the rewards. Meanwhile, sustainable economic growth provides a fertile environment for a vibrant and resilient financial system. As my colleague on the FPC, Nat Benjamin, set out last week, financial stability is a means to an end, not an end in itself. The reason we care about financial stability is because it is indispensable for economic welfare, of which long-term growth is an important aspect.

A resilient financial system that avoids systemic crises provides an important foundation for investment in innovative technologies that increase productivity growth and, hence, overall economic growth. An economy less likely to experience system-wide disruption will have a lower average risk premium in interest rates (by lowering economy-wide “tail risks” that lenders face), hence lower real borrowing costs for entrepreneurs and enterprises. Less “tail risk” uncertainty also makes it easier to do business planning, especially for longer-term projects.

In addition, financial crises are particularly disruptive for firms that rely heavily on external sources of funding. We know, for example, that firms that are more financially dependent on banks shrink more and reduce investment more in a crisis than less financially dependent firms.^{footnote [1]}

At the same time, stronger sustainable economic growth generally helps to bolster the resilience of the financial system, as described in Chapter 1 of the most recent Financial Stability Report. Innovation in the financial system can be part of this virtuous growth and financial stability circle by introducing efficiencies that boost productivity. It can also result in new services that better meet the needs of households and businesses, contributing to growth that can enhance financial stability.

Innovation, however, can also present new, or emerging risks, which policymakers need to be on top of. It can alter market correlations and interconnections, increasing systemic risks. Although very different in many ways, there are some parallels with the GFC, where the US subprime crisis, for example, showed how innovation via the development of new instruments, namely mortgage-backed securities, as well as regulatory changes that eliminated barriers to inter-state banking, transformed a fragmented housing market into a highly interconnected one, reducing diversification benefits and amplifying the possibility of tail risks.^{footnote [2]}

Macroprudential policymakers around the globe therefore need to pay close attention to new and emerging risks, as technological, economic, geopolitical, and broader societal shifts change the landscape in which they operate. That means identifying, assessing, and responding to new risks – whether they arise from technology, market structure, or global developments.

Today I wanted to use this opportunity to set out how I personally approach these issues.

How to consider emerging risks: a practical guide

As noted in the introduction, at a high-level, there are three stages to my approach: understanding the innovation; identifying and assessing risks; and determining the policy response (if appropriate). Here I am going to tackle one aspect of the second stage, namely, the identification and assessment of new and emerging risks from innovation and change.

This framework appears simple but executing it is not straightforward for three key reasons.

First is that, when it comes to identifying emerging risks, the terrain that we need to monitor is vast and uncertain – spanning, for example, domestic and international developments, new technologies and business models. Nobody has perfect sight of this terrain. For example, from my day-to-day experience on the FPC, the wide and varied experience of the members of the committee does mean, to its credit, that it is able to take a broad lens. But policymakers and regulators can and should also learn a lot too from our engagement with others in the public and private spheres when building this view.

Second is that, once a potential risk has been identified, surveillance is key. But a major issue with risks that are “emerging” is that we often will face a lack of available data to analyse.

Colleagues at the Bank work hard to close data gaps – whether, for example, that’s acquiring novel datasets for commercial providers to help understand private markets, or analysis of on-chain transactions and digital markets in the case of stablecoins. We also make use of qualitative insights, for example through market intelligence or through conducting surveys.

In some cases, our existing surveys or data collections have been able to shed light on dynamics, even with respect to these new developments. For example, the Bank’s Systemic Risk Survey, which captures market participants’ views on risks and confidence in UK financial stability, is one useful source. For example, recent surveys have allowed us to track how over the past decade concerns about geopolitical risk and cyberattacks have been climbing (Chart 1). This has helped shape our analytical priorities and made cyber risk, for example, a key focus of our work this year as set out in the recent Financial Stability Report.

Given the potential scarcity of data and information we therefore need to approach this work with a good dose of humility. We are never going to be able to predict the next crisis with any degree of certainty.

The third challenge in my approach comes from assessing the implications of a newly identified risk – the potential financial stability impacts that will help determine the cost-benefit analysis.

At the heart of this approach is a recognition that while innovations are, by their very nature, new, the channels of potential financial stability risks are not. The key for macroprudential policymakers is being creative in understanding how to apply these existing risk channels in a new context. A simplified framework, which distils the many possible risks (old and new) into a smaller number of categories, can help them manage complexity.^{footnote [3]}

This means that even when we lack information and data, policymakers should not have to ‘fly blind’. We can use analogies from past market developments to assess new risks. And with those past experiences in mind, we can break risks into a manageable number of categories and consider, as part of this, how the innovations may potentially alter historical correlations.

As I have spoken about before, I find it useful to break down the many possible channels of risk or sources of fragility into three categories of vulnerability: leverage, liquidity, and interconnectedness.^{footnote [4]} In each of these, policymakers face choices involving trade-offs and risk appetite. For example:

• Leverage: High leverage means a smaller cushion against losses – which makes the financial firm less resilient. But leverage can also mean more credit, which could finance productive growth.
• Liquidity: Business models that involve maturity transformation – for example because liabilities are short-term while assets are long-term – introduce a mismatch that can be the source of asset fire-sales and runs. But such business models can help shepherd savings towards potential investors or borrowers, in service of growth, by transforming longer-term lending into short-term liquid instruments such as deposits.
• Interconnectedness: As different parts of the financial system interact, these can result in dependencies, which can cause idiosyncratic problems to ramify and to amplify through the system, resulting in unexpected correlations and systemic crises. However, interconnections can also facilitate the most efficient flow of savings to projects wherever they may be around the world, fostering investment, innovation, and growth and smoothing consumption.

I find this three-way break down a manageable and useful way to investigate potential risks from innovation. Past experiences in monitoring, supervising, and regulating risks in the past then provides useful guidance so we are not starting anew. This approach then allows us to generate the key questions and scenarios necessary to identify and assess risks arising from innovation and change.

This approach can be put into practice through, for example, system-wide exploratory scenarios (SWES).^{footnote [5]} While these exercises are not necessarily about examining ‘new’ risks the system-wide approach they take and, importantly, the cooperation they require between policymakers and market participants can help both sides better understand risks and fragilities in new contexts. In this way they allow us to explore interconnections and seek to quantify the impact of leverage and liquidity. They can also help to identify data gaps that are inevitable when dealing with innovation and set priorities for data gathering that is useful both for risk management by the market participants and risk monitoring by the supervisors.

Let me use the next part of my speech to illustrate this framework with two examples where we have seen significant innovation and change in recent years and where policymakers and regulators (including the FPC and FMIC) have had to adapt to respond effectively to balance the significant opportunities with the potential risks: stablecoins and private markets.

Example 1: Stablecoins

Distributed ledger technology and tokenisation have the potential to change and enhance the way the financial system operates. It could reduce frictions in transactions, potentially offering 24/7 operation and near-instant settlement. Stablecoins, which are based on the technology, and which have seen significant growth in recent years (Chart 2), can therefore offer opportunities to consumers. For cross-border payments, stablecoins may offer a more efficient, faster or cheaper way of making remittances. More generally, digital assets, including stablecoins, are playing an increasing role in international trade but also have implications for cross-border crime and sanctions.

It's clear therefore that this transformative technology is something policymakers need to take seriously and prepare for the possibility of widescale take-up. In the UK, the Bank of England and the Financial Conduct Authority (FCA) are developing regimes for systemic and non-systemic stablecoins to ensure appropriate resilience.^{footnote [6]} Other jurisdictions, including the US, are also in the process of designing and finalising their regimes. Here in the UAE, stablecoin use is growing strongly.

Starting with leverage. In the US, the GENIUS Act explicitly prohibits stablecoins from paying interest. But retail investors are able to lend their stablecoins via DeFi lending platforms in exchange for interest payments. Stablecoin borrowers then use the borrowed stablecoins to make highly leveraged purchases of crypto. In this way DeFi lending platforms are able to operate like highly leveraged ‘banks’ but without the equivalent regulation and supervision. This is despite the fact the international community is committed to ‘same risk, same regulation’ as a core principle. In the event of a significant enough fall in the price of cryptoassets this could lead to a deleveraging process and the potential for fire sales. Policymakers will need to be alert to the dynamics going on here and the potential for spillovers into the wider financial system. The FPC continues to judge that, while unbacked cryptoassets are growing in popularity, systemic risks to UK financial stability remain limited.

Turning to liquidity – the promise to pay a fixed value, backed by assets with variable value, captures an inherent risk. Stablecoin issuers assure holders that the value of their holdings will remain fixed, but invest the cash they receive from holders into, for example, securities, whose value can rise and fall. It is possible that, in response to rapid and significant redemptions by holders, or due to losses in the value of those securities, stablecoin issuers’ resilience comes under pressure because of these liquidity risks. The Bank’s thinking on how to mitigate this potential risk is visible in the proposal to require 40% of backing assets to take the form of unremunerated deposits held at the Bank of England.

The existence of stablecoins can also exacerbate liquidity risks elsewhere in the system – an interaction between liquidity and interconnectedness. In particular, there is a risk of reduced lending to businesses and households as the economy adjusts to these new forms of money (a ‘bank-coin nexus’). In previous stress scenarios, such as the GFC, depositors rapidly moved funds from some banks into other banks which were perceived to be safer, as well as into cash and other safe assets. In any future banking stress, digital money could provide additional perceived safe havens for depositors to move into, potentially at speed.

The liquidity risk channel for stablecoins will vary across countries depending upon how heavily they rely on the banking sector for the provision of credit. In contrast to the US, where capital markets play a larger role, for example, banks play a larger role in credit provision to UK households and businesses. Significant and rapid outflows of bank deposits into digital money could therefore lead to potential reduction in credit for UK businesses and households if the banking system were unable to increase, at scale and at pace, its use of wholesale financing from non-banks. This is something that the Bank has given considerable thought to – as evidenced in its recent publication of a financial stability paper on this very subject.

Finally, considering the importance of interconnectedness – here policymakers need to ensure they understand the risk of contagion between important nodes of the financial system when one comes under pressure. One such risk is the potential for a loss of confidence event to result in stablecoin issuers being forced to liquidate their backing assets, with potential spillovers to core financial markets such as US T-bills and UK gilts (a ‘sovereign-coin nexus’). Recent BIS analysis (Ahmed and Aldasoro, 2025) indicates that stablecoin issuers are already exerting some influence on short-term yields in US Treasury markets. There is also a risk that, in stress, this influence could extend up the yield curve.

In the UK specifically, action to limit the risk of contagion between different parts of the financial system is also evidenced in some of the backing assets design decisions that the Bank is proposing. For example, unlike in the US, EU or FCA regimes, the Bank’s regime for systemic stablecoins proposes not to permit commercial bank deposits to be backing assets. Past events (e.g. USDC’s exposure to Silicon Valley Bank) illustrate why interconnections between stablecoins and commercial banks can transmit shocks in both directions. By not permitting this in the systemic stablecoin regime, the Bank’s proposed regime is looking to act as a handbrake on the potential for distress in one part of the system to transmit to another.

This exposition isn’t intended to be exhaustive. But it showcases the complexity of the cost-benefit analysis that policymakers (including those of us on both the FPC and the FMIC) have had to explore in coming to views on the nature of the risks related to this particular innovation.

It is important that, as part of policymakers’ deliberations, they engage and work with private industry, benefitting from their perspectives and learning together. For example, when it comes to the tokenisation of assets, the Digital Securities Sandbox (DSS), launched with the FCA, is one way in which we can ‘learn as we go’. The DSS is a regulated live environment, where we can learn from how tokenisation and DLT-based transactions take place in the real world. By initially limiting the scale of transactions we can, as Deputy Governor Sarah Breeden set out recently, do that learning safely, without putting financial stability at risk. One of the challenges is that successful digital innovations can scale extremely rapidly so it is important to have clear plans in place for graduation from the sandbox. In addition, the Bank’s recent consultation paper on systemic stablecoins demonstrates how engagement with industry and stakeholders has informed its approach to designing a regulatory regime for systemic stablecoins - evolving in what I believe is a positive direction.

Example 2: Private markets

The second example I want to highlight is the growth of private markets, whose role and size worldwide have growth significantly since the GFC as the non-bank sector has grown generally (Chart 3). Private markets encompass different types of finance, including private equity and credit, covering infrastructure, real assets, real estate and venture capital.

Over the past 15-20 years private markets have expanded at a remarkable pace. Globally, assets under management in private markets now stand at around $16 trillion. Of this, around $4 trillion is committed capital from limited partners that has not yet been drawn down (known as ‘dry powder’) (Chart 4). These markets have become integral to the financing of businesses, supporting innovation, investment, and employment across a range of sectors – from technology and communications to consumer goods and services.

This growth has been driven by several factors. The prolonged low-interest rate environment following the GFC encouraged investors to seek higher returns outside the more traditional finance and public markets. Private markets, characterised by higher returns and seemingly lower volatility, were positioned as offering superior risk-adjusted returns compared to public markets. Private markets’ long-term “patient” capital and flexible terms also attracted corporates seeking alternatives to traditional bank financing.

The financing of corporates is an area where this is notable, in that private and wider market-based finance have gained market share from banks. While bank lending accounts for the vast majority of household and SME borrowing, and a significant portion of large corporate loans, large corporates in particular led the diversification of corporate funding after the GFC. In the UK, private equity (PE) backed corporates now account for around 15% of total corporate debt and 10% of UK private sector employment (over two million jobs).

We’ve seen that dynamic play out here in the Middle East as well, where private markets have stepped in to help fill the gap left by a downturn in more traditional lending. And more specifically, private credit is helping to finance much of the recent expansion of Artificial Intelligence (AI) data centres in the Middle East. This draws together a set of complex issues: the role of AI in supporting growth and innovation and the assumptions about its success that underpin valuation of AI companies, the dependencies on infrastructure such as data centres to unlock those very benefits, and the financing arrangements needed to support these investments. The increasing interconnections between those firms could be the subject of a speech in itself, and I will save that for another day.

From a financial stability perspective, there are a number of desirable features in this diversification of funding sources for corporates. That banks are now more selective in how much of the riskiest forms of lending they maintain on their balance sheet is a sign that – relative to the run-up to the GFC – the incentives to take better account of the underlying risk of their lending are effective. This in turn shields households’ and corporates’ deposits from those higher risks, reduces the dangers from interconnections and systemic contagion that occur when banks fail, and – alongside an effective resolution regime – reduces the need for government intervention to support banks. In addition, many private market investors are, in principle, better placed to absorb losses without causing systemic contagion.

There is also evidence in the literature that private equity ownership enhances portfolio firms’ operational efficiency, driving innovation, investment and financial performance. These benefits often persist beyond the PE exit and remain during periods of economic turmoil, including the GFC and the Covid pandemic.^{footnote [7]}

But while the expansion of private markets has brought clear benefits – broader access to capital, greater competition, and more diverse sources of finance – the concern is that it has also introduced new risks to financial stability.

If I apply my framework:

First, there is the widespread use of leverage. Many private equity-backed corporates are highly indebted, making them vulnerable to refinancing risks, especially as interest rates rise and investor sentiment shifts. This vulnerability is exacerbated by the opacity around them. Unlike public markets, private markets have fewer disclosure requirements, and valuations are often subjective and updated infrequently. This lack of transparency makes it difficult for regulators – but also for market participants themselves – to assess risks, do their own due diligence, and monitor developments effectively.

For example, to date, AI development financing has largely been via equity investment. If, however, the degree to which AI development is funded by debt increases, as projected this decade, the financial stability consequences of any AI-driven fall in asset prices could become more material. Banks also engage in lending to private equity funds, most notably through net asset value (NAV) based facilities – loans secured against the NAV of a fund’s portfolio known as ‘NAV financing’. These facilities enable funds to increase their leverage and introduce what is often referred to as ‘leverage on leverage’, amplifying both potential returns and associated risks. In addition, banks have exposures through subscription credit lines, which are secured against investors’ capital committed to PE funds but not yet received. These facilities allow funds to deploy capital and make investments without waiting for capital from investors.

Second, institutional investment is supposed to ‘locked in’, reducing the liquidity risk. However, as retail investor participation in private markets increases this may become more of a risk. Retail investors may, for example, expect greater liquidity than these long-term, illiquid assets can provide, potentially leading to destabilising reactions under stress. We are also seeing funds increasingly use other strategies to provide returns to investors in a world where it’s difficult for them to manage the end of funds where traditional exit routes like IPOs are not possible (at the desired valuations) – such as continuation vehicles that transfer ownership of selected portfolio companies to a new fund.

Third, the interconnectedness of private markets with banks and insurers has increased. Banks remain major providers of leverage and arrange syndicated loans for private market funds, while insurers and pension funds are significant investors. These links mean that shocks in private markets can quickly transmit across the financial system, amplifying systemic risk. In addition, in the US, a growing number of private market firms have acquired life insurers and reinsurers. Differences in insurance regimes between jurisdictions have encouraged the growth in funded reinsurance arrangements between insurers and reinsurers. As the FPC has previously noted, the growing interconnection of private market firms to the global insurance sector via complex arrangements makes it difficult for regulators and market participants alike to assess risks holistically, including to insurers.

The challenges of appropriate valuation of firms that are not publicly-traded and, hence, where there is no market price, could generate interconnection risks. For example, if a large high-profile private firm were sold at a valuation substantially below its reported valuation, that could lead to a substantial downward revision of values across the sector. This scenario may prompt investors to engage in fire sales in the short-term and subsequently exit the sector over time, thereby diminishing the capital available to the real economy. If direct liquidation of private firm holdings is prohibited through “gates” or sales restrictions, losses sustained on those assets may compel investors to liquidate other portions of their portfolios. We certainly observed these “unexpected correlations” during the GFC and it is important to understand and explore such potential interdependencies in this context.

The rapid growth, complexity, and cross-border nature of private markets heighten systemic vulnerabilities. Data gaps and limited transparency hinder effective monitoring and risk management.

One approach to addressing these gaps are system-wide exploratory scenarios, as noted above. Last week the Bank announced plans for a second system-wide exploratory scenario (SWES) exercise focused on the private markets ecosystem. This will be run in collaboration with a group of banks and NBFIs active in these markets. The exercise will explore potential risks and dynamics associated with private markets and related risky public credit markets through understanding the actions taken by banks and NBFIs active in private markets in response to a shock, and how these actions might interact at a system level. It will also aim to understand better whether these interactions could amplify stress across the financial system and pose risks to UK financial stability and the provision of finance to the UK real economy.

I expect the exercise to build on the positive experience of the previous SWES – which aimed to improve the Bank’s understanding of the behaviours of and interactions between banks and NBFIs during stressed financial market conditions, focusing on public markets. That was done in collaboration with participating members and helped us gain a much richer understanding of the complex behaviours that could occur in stress.

Enhancing the transparency of any system-wide dynamics in a stress should help private market participants, and others in the system, to better manage the risks they face and allow us as policymakers to make better informed judgements about the risks in that ecosystem and set priorities for filling data gaps.

Conclusion

As policymakers we must all take care not to stifle the gains that innovation can bring. Innovation is the engine that powers productivity growth. In a rapidly evolving and uncertain global economy, embracing innovation is not optional – it is essential for competitiveness and prosperity.

Financial stability provides the foundation on which sustainable growth rests. A resilient financial system ensures that credit flows smoothly, markets function efficiently, and confidence remains strong. Instability, by contrast, undermines investment, disrupts planning, erodes trust, and can raise real borrowing costs for entrepreneurs and enterprises. Stability and innovation need not be opposing forces; they can be mutually reinforcing. Financial stability provides the environment for risk-taking and creativity, while innovation strengthens the economy, reinforcing stability in turn.

How to enable and encourage innovation while maintaining financial stability is a challenging and complex task. I have tried to outline here a practical approach that will break down this problem into manageable and familiar elements. My focus here has been on the identification and assessment of risks that can feed into a cost-benefit analysis. Channels of risk and fragilities related to familiar categories of leverage, liquidity, and interconnectedness provide a manageable way to organize the risk analysis and to generate scenarios to explore with market participants.

The goal is not to slow or deter innovation but to understand the upsides and downsides, particularly from a system-wide perspective. Scenarios analyses, such as those in SWES-type engagement with market participants, are useful tools that can reveal where fault lines might be and where more data would be most useful for improving risk management and monitoring.

One practical aspect to this approach is that applying this framework can help highlight where the most important data and information gaps are, and where priorities for data collection are. This in itself can be valuable insight for both the private sector to enhance risk management and for policymakers to understand risks. Indeed, a key lesson from the Bank’s first SWES exercise was that by being willing to provide results and feedback to participants, we can obtain good cooperation from them. This information and feedback is valuable to allow market participants to improve their understanding of risks and risk management practices. At the same time, it allows macroprudential policymakers to develop a better understanding of risks that then help to set priorities for data collection and monitoring. Engagement should be a two-way street. Industry insights can be invaluable in shaping effective responses and help us co-create resilience in the face of emerging challenges, particularly where information or data may be lacking.

Ultimately, innovation drives growth, and stability sustains it. Managing emerging risks requires humility, adaptability, and collaboration. By combining these principles, we can foster resilience and prosperity in an increasingly complex financial landscape. Such an approach that breaks down the new into familiar channels of risks and fragilities can, I hope, help us to act decisively without overreacting to uncertainty.

Thank you.

I would like to thank Pippa Lowe, Maighread McCloskey and Victoria Monro for their assistance in preparing this speech. I would also like to thank Rashidat Animashaun, Martin Arrowsmith, Sarah Ashley, Sarah Breeden, Owen Lock, Francine Robb and Gian Valentini, for their help, advice and comments.